Need to understand stock options so as not to appear a total noob...
April 23, 2014 5:11 PM   Subscribe

I believe I am bring offered a job for which I just interviewed for. The president of this technology company emailed me and told me my compensation would be: x dollars base salary + y dollars in stock options. This does not seem to be a publicly traded company so I'm not sure what this means or what I would even need to ask to properly evaluate the offer...

I've read a few basic tutorials on what stock options are but would be open to suggestions of what to read. I have never owned any stocks, let alone their options. My best guess from this rather casual correspondence is that over the course of a year, I would earn y dollars worth if company stock which could at some point be converted to cash and that may it may not be lucrative. I'm sure I can ask them for all the fine print details but I'd like to understand this whole realm a big better before asking specific questions.... Thanks in advance!
posted by anonymous to Work & Money (22 answers total) 5 users marked this as a favorite
I know next to nothing about stocks. I have had stock options in the past as a sign-on bonus though, and this is my rudimentary understanding.

You don't actually own anything when you have stock options. It's not like a stock. What you have is simply the right, or option to purchase said stock at the price it was on the day it was issued.

Say you had 1,000 options on stock XYZ, and it was issued to you when a stock of XYZ cost $1.

Fast forward 20 years. XYZ is now worth $20 per share. If you were to buy 1,000 stocks, it would cost you $20,000. However, since you have options, you only have to pay $1,000 (a thousand stocks at a dollar each!).

Then you can do whatever you want: sell them immediately, hold on to them, whatever! It's nice.

However, what if in 20 years the value of the stock is $0.00001. Basically worthless. If you'd invested $1,000 in the stocks, you'd have lost that $1,000. But since you just got an option, you don't lose anything (since obviously you're not going to buy them at your $1 each option when you could get them cheaper.)

For me, I was forced to choose whether or not to exercise my options 6 months after I left the company. Also, I only accrued them over the course of several years, and in fact, I don't know that I even accrued them all. But at any rate, the stocks were worth more than when I got them on the 6 month mark, so I exercised them and took the cash, since I wasn't interested in owning the stocks.
posted by brenton at 5:27 PM on April 23, 2014 [1 favorite]

Generally speaking, an option is an instrument granting you the right -- once it matures -- to buy shares up to a certain number at an agreed upon price, regardless of what the stock is trading at the time you exercise the option.

"y dollars in stock options" doesn't really have a defined meaning unless there is a current market value for shares in the company (which is difficult if it not publicly traded) or (and this would be quite unusual) unless the option is to buy shares at a certain dollar discount under their trading price (but again, what is their trading price if they are not traded?) when executed.

Putting a value on options which are not yet exercisable is pretty complicated, so you're right to be confused if you are being offered "y dollars in stock options."
posted by Nerd of the North at 5:27 PM on April 23, 2014 [2 favorites]

Here is some useful information with some questions you should ask.

It's also worth noting that there's good reason to believe that the current run-up in tech stocks is an unsustainable bubble, so there's a decent chance that the value of the options you're being offered will be zero.
posted by ewiar at 5:32 PM on April 23, 2014 [2 favorites]

If the company never goes public, your options are essentially worthless (unless the company is doing well enough that there's a pre-IPO market of people willing to buy your options from you).

The math you need to to do for options is (the total number of options they're offering)/(the total number of outstanding options) * the current valuation. If you think they eventually might be worth billions, you can substitute your best guess for future valuation to get an idea of your best case scenario.

That all represents what could be. How to evaluate what they're offering is to look at (the total number of options they're offering)/(the total number of outstanding options)*100, which will tell you the percentage of the company you ultimately could own. You should compare the percentage they're offering you vs. "standard" offerings (for example: to see if they're low-balling you in terms of equity given the stage the company is in and your prospective role.

Without the number of outstanding shares, the current valuation, and the knowledge of how much equity is usually offered for your role/experience/stage in company life cycle, the actual number of shares is a meaningless number. Any place worth working for is not likely to volunteer this information, but if you ask, they should absolutely give it to you without hesitation. Not doing so should pretty much end the conversation on your part.
posted by NoRelationToLea at 5:33 PM on April 23, 2014 [1 favorite]

Just disregard the options in terms of compensation. Consider it a bonus that may pay out in x years, if the company takes off.
posted by yclipse at 5:34 PM on April 23, 2014 [8 favorites]

It's a little weird to see "y dollars in stock options". Usually the language is something like "X shares of stock options at $Y per share".

The basic premise of stock options is, at least for ISOs (incentive stock options), after some period of time, your options vest - that is, you get the option to buy X shares of company stock at $Y per share, regardless of the market price of the stock at the time. Buying these shares is called exercising. If the company goes public, you can then sell the shares like any other. i'm not sure what you can do with them while the company's private.

Stock options can be nice, but the tax laws around them can be gnarly, so you'd have to dig a bit.

Personally, I'd ignore the stock options until you're sure the company can do well and take off. If you buy them as soon as they vest and your company tanks, you're out a bunch of money. If you don't, no harm done.
posted by curagea at 5:45 PM on April 23, 2014 [1 favorite]

So far, a lot of good advice and comments in this thread, and no misinformation that I can see.

ewiar: It's also worth noting that there's good reason to believe that the current run-up in tech stocks is an unsustainable bubble, so there's a decent chance that the value of the options you're being offered will be zero.

Let's be dead honest: ewiar's statement is true in the very best of times. Most startups fail. Period.

You are being offered the classic "lady or the tiger". Those options are very likely to be worthless in the long run. Period. End of statement. If your company has better-than-average odds of going public and going big, you don't have the experience and insight to judge that (no offense intended). So, it's a crap shot.

Do you think the job will be worth it, in resume bullets, real life experience, networking opportunities, and raw salary to make it worthwhile? Do it. The stock options might be a helluva Christmas bonus some year.

If not, odds are the stock options are worth half the paper they're written on.

I did it, because the job was filled with moral and professional validation for me, and boosted my resume in a direction I wanted to take my career. The entire company just sold for a fraction of a penny a share. I don't regret one hour of unpaid overtime.

Make the call as though the options weren't there, because they probably aren't.
posted by IAmBroom at 5:55 PM on April 23, 2014 [10 favorites]

I was at a company that was not publicly traded, and which issued us stock options so we wold have some ownership incentive to work harder to make the company better and more valuable if it was ever sold.

The day the company was sold and publicly traded and those options became worth something, we all got a nice letter telling us that there was a fee for exercising our options, a fee that someone had pulled out of their ass that was conveniently just slightly more than the value of the stock. The letter went on to assume that we would therefore not be taking advantage of our options. Hopefully your place won't be so sleazy, but my point is there are so many ways for stock options to come to nothing.

Don't put weight on the stock options. Perhaps take the angle that stock options are a fee the company chooses to exchange for getting more employee skin in the game, ie they get their value back out of it, so it's not something you should see as lowering your salary expectations except under exceptional circumstances (such as massive options for a company you absolutely believe will go big)
posted by anonymisc at 6:10 PM on April 23, 2014 [1 favorite]

The tough thing about options in private companies is that they're hard to convert to cash, so it would be helpful for you to see if the company will redeem them and if they can be net settled. Also: you'll want to know if they're incentive stock options or nonqualified options. Tax treatment is very different.
posted by jpe at 6:16 PM on April 23, 2014

My experience with start-up "sloptions" roughly maps with everyone above.

There is no tax liability until you exercise them, AFAIK, so don't worry too much about that.

Typically there is boilerplate that you cannot sell them privately, so you have to wait for an IPO or sale of the company or they will be forever worthless.

Also important to note, even after they vest, they are still "options" to buy. The only reason you might have to buy before they have value is if you leave the company. At that point you have the option to buy what you have vested and own imaginary shares in the hope they someday have value, or give them up forever.

As far as the "dollar amount of options" thing, I have no idea what that means. I've always seen it expressed as X shares, vesting 25% after the first year and then Y per Z time unit thereafter, with a strike (buy) price of Q (usually a very low number between 2 and 10 cents).

Don't be embarrassed to just ask them to explain what the hell they mean. If no one here knows it's certainly non-obvious.
posted by drjimmy11 at 6:24 PM on April 23, 2014

I have offered equity to employees. I agree that you should consider it $0 towards your compensation package and enjoy the nice reward should you have a liquidity event. Enjoying the people you work with is much more important than maximizing the equity amount, which to be honest for non-founders (or to be general, employees being paid a 'normal' salary) will be negligible for 99.9999% of the companies out there. If the equity isn't making up for absent or very low salary, it's just sprinkles on top.

'$X in options' only makes sense today since the valuation is $Y and you have Z% of that, but the former is made up and the latter changes drastically as the company matures and you take on more capital or dilute the pool in other ways. It's really hard to quantify in a generic sense, so ask a trusted friend you can share the details with.

There can be a tax liability if you purchase (which is not the same as selling) the shares: once you vest you can exercise, but possibly not sell since it's still private. If the Fair Market Value is more than the option price, you owe a very significant amount of tax on your made-up gains that year. Yes, even if you never get the chance to sell the shares. This is being a thousandaire on paper and can lead you down a path of negative value, but only if you exercise/purchase them once you've vested. 83b elections can get around this but I doubt you have that option.
posted by kcm at 6:31 PM on April 23, 2014

Stock options are pretty simple: you are offered X options at a "strike price" of $Y, which vest on a given date. That means that on the date the option "vests", you are allowed to buy shares of stock in that company for $Y each, regardless of what the actual value of the stock is at that time. If the stock is worth more than $Y, you win; if it is worth less than $Y, all you can do is hope the stock price goes up before the options expire. The vest date is typically some fixed number of months/years after you start working, often on a running basis where a portion of your options vest each month (this is so everyone in the company doesn't retire to lives of wealth and leisure the day after a successful IPO.)

Before the company goes public, options can't be exercised; until that happens (if it ever does) they're just numbers on paper.

There is complicated tax stuff, yeah. But you don't care about the tax stuff because it only becomes relevant after you win, and only affects the degree to which you win, and it's not like you're going to turn down the win because some of it will go to the IRS.

I've worked for a bunch of startups. Hit the jackpot with one; would have done with another but simply failed to exercise the options before they expired (yes I am still kicking myself); others turned out profitable eventually but at the time I could have exercised my options it would have been cheaper to just buy stock on the open market; the rest never went public.

It is basically impossible to predict whether your options will be worth anything -- it depends on too many factors outside of your control (or frankly anyone else's control.) Judge your compensation based on the salary; treat the options like a lottery ticket because that is effectively what they are.
posted by ook at 6:31 PM on April 23, 2014

The first time I was offered stock options, I countered with "keep half the options and give me $X more in base salary." I was there five years, the options never amounted to anything despite the company being successful because it was during the first dot com crash. Nobody got raises during those five years either, so I was glad I got the initial salary bump instead.

The second time I was offered options, I tried the same thing and they didn't go for it, but I took the job anyway. I've gotten steady raises and bonuses over the last eight years, but the options were priced high and the housing market imploded, so those options were worth nothing...until this year, where they've been worth (post tax) anywhere from nothing to $18,000 depending on the fluctuations of the week. I'll invoke the option when I like the price, or when the options are about to expire, whichever comes first.

Best to think of it this way: options might be free money of an indeterminate value, or might be worthless, depending on a lot of take the options, but don't factor them into your judgment of how much they're offering you. It helps to think of them as "here is your base salary, and you will also receive $x in lottery tickets."
posted by davejay at 6:58 PM on April 23, 2014 [1 favorite]

"here is your base salary, and you will also receive $x in lottery tickets."

Yeah, I was actually about to say that consider that he just told you that the options are scratch-off tickets -- and you'd probably be better off with scratch-off tickets.

I've been offered options a couple of times and they've never ended up being worth anything.
posted by empath at 7:21 PM on April 23, 2014

As mentioned, "dollars of options" is weird and wrong. Ask them what percentage it is.

My first rule of thumb for options is not to consider them as a part of compensation at all, ever. They are gravy, and likely worthless gravy at that. Do not let them tell you that you should take a lower salary because you are getting "options," "extra options," or "more options than they usually give."
posted by rhizome at 7:21 PM on April 23, 2014

Typically employee stock options are given with a purchase price in line with the company's current valuation. That is, you're being offered the same deal that the investors got last time they bought into the company. The investors hope to make money but they realize they probably won't be able to. So stock that might sell during an IPO at $12/share might be valued, by investors, at $0.10/share, which kind of reflects their view on the odds.

This means that if you COULD exercise the options (you might be able to), and COULD sell them (you can't), you'd get roughly what you paid for them. So there is a very real sense in which they are directly worth $0.

Now it's true the price is only re-set rarely - usually when there's another round of funding. Which means if the company has been doing well, the "real" value is a bit higher than the strike price. And they're a little better for you than they are for the investors, because you have a lot less risk - if you stay at the company, you can wait until the IPO before you buy the stock at those prices. They had to buy in early (so the company has money to pay you with). Normally if you leave the company though you'll have to exercise your options (buy the stock) within 6 months of leaving, or lose the options. At that point you have to guess whether you think the company's going to amount to anything, and can you afford to have however much tied up in stock that might be worth something some day.

It's also worth mentioning that most companies funded this way don't IPO. Some fail, and a lot get bought. If the company's acquired because it's doing well, then that can represent a significant payout. If the company's floundering though, options might pay out very little or nothing.

Short version: Value them like lottery tickets. Usually they're worth nothing. Sometimes they're worth a moderate amount, and very rarely they're worth a lot.
posted by aubilenon at 7:31 PM on April 23, 2014

But back to your offer: I have never had my options described to me as "worth x dollars" in an offer. What they normally should tell you is: how many shares, at what "strike price", and on what vesting schedule. The strike price is the amount you would pay to buy the shares; the vesting schedule is how long you have to work there to actually earn the options - industry standard seems to be about 4 years for any given option grant, usually 1/4 at your first anniversary, sometimes 1/48 each month thereafter, sometimes 1/4 at each subsequent anniversary. If you quit before the options vest, you don't get to use them.

The additional information you would need to properly evaluate the option grant for a pre-IPO company would be the total stock outstanding and the funding situation of the company: how much capital has been invested, and how big a stake in the company that bought. It is also helpful to have an idea of how many more rounds they are likely to need before they expect to have a self-sustaining business: generally, with each round, the previous stock is diluted in value. What you want to be able to do is figure out what % of the company you'd own if you could exercise those options.

I have been through this half a dozen times, with startups and larger companies. I have never made a penny on start-up options. On the other hand, options from medium sized companies, issued shortly before they went public, have actually been worth something.
posted by mr vino at 7:47 PM on April 23, 2014

Anon, I've been through the stock option rodeo eight times. PM me and I can share advice and actual cases of good and bad outcomes.
posted by zippy at 8:38 PM on April 23, 2014

yclipse and others hits the nail on the head. Consider them funny money which may, if the stars align just right, be a small bonus much later down the road.

If you want to see how serious they are, ask them if they'd make the shares available to you as Reserved Stock Units (RSUs), which unlike options are granted directly (ie you don't pay for them).

As for tax issues, my account's line on these things is "don't worry about the tax consequences. Make your decisions about investments and securities based solely on the value of the instruments, and just let the taxes fall where they fall. Unless you're a billionaire, the money you could save by trying to optimize for taxes is inconsequential."
posted by colin_l at 8:48 PM on April 23, 2014

RSUs are 'restricted,' not 'reserved' (although that's not far off the mark).
posted by kcm at 11:18 PM on April 23, 2014

I've had options in 5 companies, ranging from start ups to multi-billion dollar telecommunications firms, and I've been through one IPO. My total income from stock options is $0.00. Listen to the people here telling you to ignore them as a decision factor in taking the job.
posted by COD at 5:16 AM on April 24, 2014 [2 favorites]

Never consider options in dollar amounts. Consider them as a percentage of the company. What you want to know is the company's "float", or total options to be issued, and what percentage of that float you're getting.

The second thing you want to know is whether there's a change-of-control clause in your option agreement: if the company gets acquired, do all of your options vest at once? If not, you want to consider what impact that will have, because almost all options cliff-vest: 25% at your first year's anniversary, and 1/48th of the total option grant each month thereafter.
posted by scrump at 3:41 AM on April 28, 2014

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