Questions to Ask Before Accepting Startup Stock Options

February 18, 2016

3:11 pm

A few months ago Jack Dorsey made a sensational announcement about offering 1/3 of his stocks back to the employees, which constitutes exactly 1% ownership stake. And that is just one example of how stock options are becoming an integral part of the employee benefit package within tech startups.  Google, RescueTime and a number of other smaller companies are placing stocks on the table as a tool to attract and retain better talent.

Before you gladly sign-off the deal and get dreamy about the millionaire retirement, you should make a realistic assessment of your options by asking the following questions.

How many shares will I be granted and under what terms?

Venture Hacks have created a good breakdown of what employees may expect in terms of equity. As a lead engineer you can be offered somewhere between 0.5%-1% of companies shares. Considering that you don’t participate in further investment rounds, you can expect to walk away with $500.000 or $250.000 in the event of a $50,000,000 exit.

All the options are typically vest over 4 years.  Most commonly success does not happen overnight.  However, the question remains – what happens with unvested shares? There are two most common scenarios:

  • The unvested shares could accelerate a.k.a. all of them could vest when the buy happens.
  • They could be converted to options of similar value in the purchasing companies.

Usually, the final decision depends on the buyer.

How many additional options will be authorized?

Authorized options are those, which have not yet been granted. Obviously, as the pool grows, your stake will get diluted.

Typically, the size of the startup’s option pool varies depending on the company’s maturity with an average figure being 15%-20% of the company’s Total Capitalization.  Having a lower pool may mean that:

  • The company is penny-pinching with the options available.
  • Massive future delusion may occur, once the option pool is expanded. Sure low-cost and penny stock can still be a valuable asset as this guide shows, however you may end up with significantly lower equity number than you have expected to receive in early days.

While increasing the option pool over time is quite common, you should still ask for an estimate of all the additional options that would be authorized before the company’s exit.

What is the best estimate of the company’s valuation upon an exit?

Obviously, at early stages the number would be more of an educated guess than an exact sum. However, a good employer should provide you with an acceptable valuation range.  Failing to do so should appear as a red flag for you.

What about taxes?

Your tax options will depend on the specific type of stock options you own and a few other variables related to your individual case.  Before you decide to exercise your options or sell shares, it’s best to consult with a tax advisor or accountant to understand the consequence of the transaction.

What is the exercise price of my initial options?

Typically, this number should be outlined in your Offer Letter and Stock Option Agreement.

Statements like “The exercise price will be based on the company’s Fair Market Value or stated by the Board of Directors.” The exercise price should be put in writing before you accept the offer. Also, make sure your company has passed are recent 409A Valuation and you have studied the data.

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Dianna is a former ESL teacher and World Teach volunteer, currently living in France. She's slightly addicted to apps and viral media trends and helps different companies with product localization and content strategies. You can tweet her at @dilabrien

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