The one number you should know about your equity grant

The one number you should know about your equity grant is the percent of the company you are being granted (in options, shares, whatever – it doesn’t matter – just the % matters).

Number of shares: meaningless.

Price of shares: meaningless.

Percent of the outstanding option pool: meaningless.

Your equity in relation to other employees: meaningless.

Strike price of options: meaningless.

The only thing that matters in terms of your equity when you join a startup is what percent of the company they are giving you. If management tells you the number of shares and not the total shares outstanding so you can’t compute the percent you own – don’t join the company! They are dishonest and are tricking you and will trick you again many times.

I find it really depressing how often employees, especially engineers who are so smart about other mathematical issues, don’t get this. I felt forced to post this after talking to a friend today who told me about how a prominent NYC startup has been telling hires the number of shares they are granted but won’t tell them the percent those shares represented (“it is company policy”), or the number you need to compute the percent – the total outstanding shares. It’s really amazing people are getting away with this simple and incredibly cynical trick.

I’ve seen many companies “split the stock” 10-1 so that instead of, say, 10M shares there are 100M shares outstanding so the absolute number of shares granted sounds really big to naive hires who don’t understand that all that matters is the percent they own.

I think every engineering school in the country should have a week-long course on the basics of the capitalization of startups. There are other things that matter too, but far less (like the number of preferences outstanding). I’ll try to write about these other things in later posts.

Engineers – here’s how equity is paid out in a normal company sale/IPO (assuming a “good” outcome – in the downside cases it’s more complicated as investors have preferences which act like a max() function). You get the percent you own multiplied times the price the company was sold for (or the market cap after IPO). That is why percent ownership is the only equity number that matters. Don’t work for someone who tells you otherwise or won’t tell you what percent you own.

http://davidcancel.com/ David Cancel

I agree completely, especially about the education bit.

One big issue that this brings up, and maybe a topic for a future post, is how to handle subsquent rounds when you’ve trained people around %s. Especially if you live through a down round.

In my experience it’s easy to talk %s in the early days of a startup. Very hard later to deal with everyone wanting “make goods” after later rounds of funding. Explaining “bigger pie” and the “risk has been taken out” is easy only in theory.
bill

alaways amazed at how many people mis this

but shouldn’t you also care what the strike price; i.e. valuation is? you could get 1% of the company, but if they assign you a strike price that implies a 1b valuation and the business is nowhere near that, or the promised future mega up round to which they are pegging that is still just the ceo’s fantasy, they you are also being set up for disappointment, no?
Gary

I agree that all of the above data points on their own are meaningless but if you know the share price and you know the strike price, then you can compute the current spread between the two, apply an expected return on the current share price and make a rational economic decision as to the value of those options. I love your recent blog entries but this one seems extreme and not very well thought out.
http://reecepacheco.com reece

Curious, what do you think is a fair percent offering to early employees (the first few hires after the founders)? Any major difference for engineers vs. non-engineers?

I understand there are a lot of other factors involved (salary, company risk etc), but I’d love to hear your perspective on this – perhaps given a few different scenarios (funded startup, bootstrapped startup) etc.

P.S. – I’m with you on subsistence salaries from your other recent post…
http://ericboggs.com Eric

Great post. Engineers aren’t the only ones that don’t understand how this works, that’s for sure.

Also – I think this issue is much different (and much more important) for hire #5 than it is for hire #50.
AA

I’m honestly a little confused here; I thought it was actually the other way around.

For instance, I own options to purchase, let’s say, 100k shares of company X at an exercise price of $.10 a share. The share price when I join is $2, implying that the value of my *shares* is $200k when I joint the company. Company gets acquired 3 years later; let’s say I have fully vested, and the purchase price of the acquisition came to $10 per share. I now own options to purchase 100k shares @ $10 per share, not $2, and my shares are worth $1mm, not $200k. I end up paying $.10 / share = $10k, for my shares, worth $1mm.

Where in the above do I care what my percentage ownership in the company is? I am not challenging your post; in fact, I am probably one of the idiots you’re referring to, heh, but I’m just trying to get clarity, because I will (shamefully) admit that I am not getting it, and this runs very counter to what I’ve been told by pretty much everyone thus far.
AA

venture hacks makes no mention of percentage ownership either, in answering the following question (http://venturehacks.com/articles/job-offer):

“3. What are my options worth?

First you have to know how many options you have and how they vest. Let’s say you have 1000 options and they vest over 4 years. So you get 250 options a year for 4 years.

Now you have to guess what an acquirer would pay for your shares. Let’s call this the acquisition share price. Setting the acquisition share price to the preferred share price of the last round is a good start—let’s say it was $1/share.

Now multiply your options (1000) by the acquisition share price ($1) to calculate the acquisition value of your options: $1000. Since the options vest over 4 years, the annualized acquisition value is $250/year. And while the acquisition value of your options might be $1000 today, you’re naturally hoping that the company’s acquisition share price increases over time.

If the company has gained a lot of value since the last round, you might set the acquisition share price higher than the preferred share price. If the company has not has not done well since the last round, you might set it lower. Either way, you will have to ask the company for the preferred share price in the last round. Or if someone has offered to buy the company for $50M since the last round, I might use $50M to calculate an acquisition share price.

Finally, you will have to pay for your options—they’re not free. Options have a strike price—that’s what you pay for your options. Sometimes it’s much lower than the acquisition share price and can be ignored. Sometimes it’s high and can’t be ignored—high strike prices are becoming more common due to high-valuation rounds (Facebook), founder cash-outs, and high 409A valuations.”
AA

also from venture hacks (and really sorry for the number of comments, I tried to include this in the above comment, but I accidentally hit submit too soon); I’m just trying to rationalize what you’re saying with these guys (I have always thought Nivi et all are very smart; although they very well may be, it would be crushing to realize they are wrong, heh; definitely my primary source of VC-related info)

“4. What percentage of the company do my options represent on a fully diluted basis?

Most people think this number is important—it’s not. You care about the value of your options, not your percentage of the company. Your percentage will decline over time but the value of your options will hopefully increase.

Focus on the how many options you have and the acquisition share price (see question 3 above). Terms like percentage ownership and valuation can fool you.”
Joe

Good points – but a bit draconian for a later stage startup company. That is an excellent policy if you’re a founder (or near) and you expect to get something more than 0.0001% of a company. It is also useful to know the strike price of your options and what the CFO believes will be an offer price for your shares on IPO or sell-out. That difference is quite valuable if you do the math:

(offer_price * #_of_shares) – (your_strike_price * #_of_shares) = usually a hell of a lot more than any outsider will get. Yes, only the actual percentage will tell you the real earning potential, but *nobody* will know the the offer price until the actual *second* it is sold or IPO’d.

The real bottom line is more simple: Do you trust the management, and do you believe that the company will be successful *at all*? If so, then your options will be worth something. If you aren’t sure about either of those, then walk. Now.

– Joe
chris

Sorry, I like Nivi and think Venture Hacks is a great idea, but that is simply bad finance. All ISO options at startup are granted around 20% of preferred share price. The strike price is effectively irrelevant from an options valuation point of view. I’d encourage you to read this http://www.cdixon.org/?p=259 and happy to talk about it more if you want on my blog. But basically the history of management / VC versus startup employees is the history of the former tricking the latter over option values. All of what I am saying is common knowledge is the VC community but somehow not understood elsewhere.
chris

David Cancel – As usual, great comments. I agree this gets much more complicated later on, especially with down rounds. I am definitely over simplifying. I am mostly talking about companies that are only going up in valuation and IMO deceiving hires about the value of their options.
http://wac6.com William Carleton

Chris, I think the story is even more complicated and the info needed even more extensive than the total number of shares outstanding, etc., as you described. To model value for a presumed exit, you would also need to project what additional dilution the company might undergo, and you would need to find out what the liquidation preferences were on preferred classes of stock, whether those classes were also participating with the common, etc. I know you know all this, but what’s most surprising to me is how sometimes liquidation preferences can keep common underwater. Management usually knows this, but sometimes rank and file employees do not. Good tip might be: ask your employer if it has a management incentive plan in place designed to set aside a portion of sale proceeds to key management. If so, could be a sign that the liquidation preferences are substantial, and that only the preferred (and management, to the tune of the pool) will get proceeds of a sale. Fortunately, too, one can get ahold of charters that will typically reveal much about classes of stock, participation and overhang. Eg, see my posts at http://wac6.com about Zappos and what the Zappos charter says about who gets what on a sale to Amazon (in that case, substantial value in the common remains, but the preferences may be said to “shift” a disproportionate amount of the projected proceeds to Sequoia).
http://davidcancel.com/ David Cancel

Chris – I hope that for the rest of my career I’m only in those sort of startups, the ones that only go up in valuation.

You’re over simplification is better than most people’s detailed explanations, please keep it up. I’m just adding some context for those startup that zig and zag as they mature.

Which brings me back to a question I’ve been wrestling with, maybe startups shouldn’t last beyond a “B” (round) unless the model is on the steep part of the “hockey stick”. Maybe there’s a “risk/reward” AKA “know when to fold ‘em” post in there somewhere….
http://flint.sparcq.com Umair Mufti

from a management perspective, i think it’s also important to be clear that the % granted is in flux. when the number of outstanding shares changes, so too does each shareholder’s percentage of ownership.

i try to be as transparent as possible by broadcasting this figure (shares outstanding) on our intranet. each team member then has all the variables needed to calculate his/her ownership of the company, at any given time.
http://popupchinese.com trevelyan

@AA – presumably the price offered for your shares will depend on the total number of shares in existence.
AA

Chris, thanks for posting a link to that previous post. It was helpful in understanding your view point on startup options packages in regard to fundraising, a bit better.

I actually currently work at a startup, hence the many questions/concerns I have. Only recently did I start working @ this company, so I am fairly new to the space, and my understanding of how things work at a startup is still very much in its infancy. Hence, I apologize in advance for my ignorance.

With that said, I just don’t understand where the “trick” is, or what you mean by it: I care about where the share price is today, for my shares in the company, and how much those shares appreciate by, so that when the company exits, I am able to maximize my personal shareholder value. I don’t even care about preferred price, cause I don’t have preferred equity, so whether there is a discount here is irrelevant; I am just talking about whatever the common is worth, and whatever the common stock valuation is upon exit.

Similar to, if I had equity in a public company: I couldn’t care less what percentage of the company I own, I only care about my shares, and how much they appreciate in value. The only way I would care about what percentage I own, is for voting rights/board positions/etc etc; at a startup, I’m not really concerned about these things either, since I am an employee, not a founder. (Obviously if I’m an advisor, board member, or something else, then I care more about this; and maybe this is motivating your article, in which case I apologize)

It is REALLY hard for me to refute this argument, based on nothing more than sheer logic and arithmetic rationale. Also, the percent I own is highest in value iff share price is as high as possible -> the higher the share price, the more this percentage is worth, so ultimately I SHOULD, in fact, care about share price.

I am sure there is probably some enormous disconnect in my logic, but it seems I am just not smart/savvy enough to find it at the moment; again, please forgive my ignorance here, I am just trying to wrap my brain around something that probably shouldn’t be nearly as complex as I am making it out to be.

No need to necessarily comment back; I’ve bothered you enough! Just wondering how this basic law of finance and maximizing my shareholder value could possibly be the wrong focal point. I’d love to see Nivi or someone from venture hacks comment on this, as they are clearly much smarter than I am on the topic. Maybe I’ll go shoot them a comment on VH.

Sincerest thanks for all the insight Chris, it is much appreciated.
AA

@umair isn’t this exactly why you would want to focus more on how many shares you actually own, and how the price of those shares is changing? that’s easier to track than constantly revising what percentage of the company you own after each round, i would think?
AA

some of the convo here is also interesting: http://news.ycombinator.com/item?id=248141

“In an acquisition, the preferred stock is converted to common and the acquirer pays the same price for every share of common stock.”
http://jerryji.com/ Jerry Ji

The theory is impeccable, just that in practice figuring out how much one’s Google shares are worth as percentage of the company’s total market cap can be rather unwieldy, which is why I guess some previous commenters still insist on preferring the fluffy absolute figures.

Maybe a new unit like (nano) basis point might help
Pingback: Twitter updates for 2009-08-28 » sneaker.org
http://lmframework.com/blog/about David Semeria

As Bill said, how can the strike price be meaningless?
John Stauffer

AA -

The percentage ownership (or total number of shares outstanding) is important for you to evaluate the likely future value of the options.

Imagine you get offers from two startups, each including 10,000 options. The strike price for options from Startup A are $1.00, and for Startup B are $.10.

Which offer should you take?

Now imagine 4 years later (after you’re fully vested), both startups get acquired for $100 million. Startup A has 10 million outstanding shares, and startup B has 100 million outstanding shares. Your options in startup A are now worth $10 each, while your options in startup B are worth $1.00.

Total outcome for startup A is ($10.00 – $1.00)*10,000 = $90,000. For startup B it is ($1.00 – $.10) * 10,000 = $9,000.

Now which offer do you wish you took?

It is true that your percentage ownership is not important to determine your value *once* the company has been acquired, but it’s critical to estimating the value of the options when you are granted them.

In this case, you would only take the offer from startup B if you expected them to be worth at least 10 times as much as startup A.

If you are taking the offer before at least a B round of financing, I would expect to be diluted by 50%. This is definitely a conservative estimate, but it allows for the risk of additional rounds of financing as well.
John Stauffer

AA -

The percentage ownership (or total number of shares outstanding) is important for you to evaluate the likely future value of the options.

Imagine you get offers from two startups, each including 10,000 options. The strike price for options from Startup A are $1.00, and for Startup B are $.10.

Which offer should you take?

Now imagine 4 years later (after you’re fully vested), both startups get acquired for $100 million. Startup A has 10 million outstanding shares, and startup B has 100 million outstanding shares. Your options in startup A are now worth $10 each, while your options in startup B are worth $1.00.

Total outcome for startup A is ($10.00 – $1.00)*10,000 = $90,000. For startup B it is ($1.00 – $.10) * 10,000 = $9,000.

Now which offer do you wish you took?

It is true that your percentage ownership is not important to determine your value *once* the company has been acquired, but it’s critical to estimating the value of the options when you are granted them.

In this case, you would only take the offer from startup B if you expected them to be worth at least 10 times as much as startup A.

If you are taking the offer before at least a B round of financing, I would expect to be diluted by 50%. This is definitely a conservative estimate, but it allows for the risk of additional rounds of financing as well.
http://www.bijansabet.com bijan sabet

Great post Chris.

as an aside i feel like engineers are often smarter about this issue than non-engineers in startups.

the other thing worth talking about are financing terms and their impact on employee options

for example, even if the VC terms are clean 1x, non participating pref, it’s important to tell employees what liquidation preferences mean to them.
http://www.codepuppy.com Jeff Potter

One other consideration is whether the stock is a grant or an option. If it’s an option, you have to pay the option price to convert it. If you leave the company (and the options cancel upon termination of employement) but the company is still private, you end up having to gamble your own cash – potentially a lot of it – for something that may never be worth anything.

-Jeff
chris

Bijan – I agree about preferences. I remember this was especially bad back in 2002-4 when so many companies had loaded up huge preferences so you had to sell for $100M or something just to beat the preferences. I know I am oversimplifying a lot but I’d rather have people at least asking for the % than nothing at all.
chris

AA – Forget about share prices. No one in finance cares about share prices (except as a proxy for the numbers that really matter). This is one of the most common mistakes people make in public and private investing. For public companies, professionals look at market cap (or enterprise value).

I can ask my lawyers to double the number of shares tomorrow (it’s called a stock split). Does that make my company twice as valuable?

If someone comes along to buy your company, they will offer and certain amount of money for the company. They won’t ever think about share price. (assuming no preferences and other complications), you will receive the amount they pay for the company * your percent ownership. Your percent ownership can change while your number of shares stay constant without you being notified. For example this happens when there is a financing, when the option pool is expanded, and for other reasons. Focusing on the number of shares is a trick management uses to deceive the less financially savvy.

Regarding options, the strike price matters if you are facebook and it’s $5B, but at an early stage startup with (say) 300% volatility and the common struck at 20% of preferred, it’s just not a factor. Ask an options trader or try those numbers in black scholes.
jrh

It always amazes me how many engineers don’t pay attention to the number of shares outstanding. The flip side of this is that as an entrepreneur, it makes sense to have a large absolute number of shares. Engineers will feel better about their options package — and their spouses will feel better too. It’s easier to give out a big number of shares than to explain to every prospective hire how options really work. But you should always be honest and open with people who understand what’s going on and want to know the numbers!

I think it’s also important for option holders to know if the investors have participating preferred. As an employee, you need to have some picture of the following things to know what your options are worth:
1) What the company will likely be worth in the end
2) Current company valuation, as reflected in strike price — at early stage often too low to matter but does matter if the valuation is high
3) How much the preferred shareholders will take out if they have participation
4) Of the total remaining for the common, minus the current valuation, what percentage will you get?

Another factor is that purchasing companies will often up the options grant and/or accelerate some vesting for employees they intend to keep. Yes, that’s future compensation, but it’s often keyed to what people have already.
jrh

@AA
I’ve been on both sides of the table many times and can tell you that Chris et al are absolutely right.

Focusing too much on the stock price is a classic amateur mistake. There’s no way to have any idea what the common stock price will be without knowing all the info that Chris (and others) talk about.
http://lmframework.com/blog/about David Semeria

This is basically a discussion about dilution. Not every increase in the number of outstanding shares is necessarily bad, especially if new money is needed to grow the company. 2% of $100m pie is better than 10% of $10m one.
http://www.fitnr.com Louis Marascio

I completely agree and as an early stage entrepreneur I always discuss this with prospective employees. I would caution, however, that percentages must always be described to the employee as a point in time. I always tell them something along these lines: Your grant will be for X shares, and at this moment that represents Y% of the company, however that percentage will change over time due to additional financings, etc. I never document the percentage being granted, either, in terms of offer letter or any other form. Number of shares never changes, but percentages are relative, however you must be honest with employees about what they are really getting, so I completely agree with your thoughtful post. Thanks!
GW

Chris, it’s refreshing to see someone come out and state the facts. From a best practice perspective, a related issue (which I haven’t seen anyone post about) is how best to communicate these issues to your team beyond the initial founding group. Things becomes quite complicated when you reach 100+ people, financing rounds past the initial Series A, and you have a mix of founders, early non-founding early employees and later employees on the team. If not handled correctly, it is very easy to create an environment that cancels out entirely the motivational aspects of employee equity ownership. I remember one start up entrepreneur fifteen years ago (an MIT grad) who posted everyone’s salary and ownership percentages on a white board above the reception desk. Needless to say, things turned ugly later on.
http://anyclip.com Aaron Cohen

Chris:

I think there is a broader issue here about the importance of equity compensation in startups and how its valued.

It raise many, many issues.

1. Few employees of a Venture-Financed company receive anywhere close to 1% of a company’s stock. Typically 1% goes to senior level execs who are non-founders.

Given that there are very few large exits these days numbers significantly smaller than 1% are unlikely to make non-founding employees spectacularly wealthy. Even at mature Zappos with its 700MM exit, how many people there made $1mm on the transaction? I have to be believe that number is fewer than 10 outside of founders. How many employees had .1% of YouTube post Sequoia financing and got liquid with their Google stock at that time? It couldn’t have been too many.

Equity compensation became a huge, huge part of the system in the late 90s when billion dollar market caps were plentiful and companies hired dozens of employees early in their trajectory because the IPO market was so open.

Things have changed and expectations need to be managed. In my opinion, few employees are going to see massively life changing events from their startup efforts. To be sure, founders and top executives could and will make millions if companies sell for exit north of $250mm. M

Most startup employees need to realize they are on a journey and that in addition to making a few hundred thousand dollars on a good outcome they are learning how to become more senior at the next company. Real wealth creation will take founding, seniority, or staggeringly large exits.

Good entrepreneurs and CEO should be preparing their people for careers beyond the current startup.
AA

Chris et all, thanks for the explanations. I get the point, and I def realize that a company gets bought on EV, but what I’m now beginning to realize, is this is all the same thing. When you say “you should only care about %-age ownership”, that’s basically the same thing as “you should care about share price, number of shares you own, and number of shares outstanding”. ultimately, what’s the difference here, seem like the same thing? I don’t know if there is one (in most cases). I think maybe I was wrong in saying share price is the easier number to track, because in this case you actually have to keep track of how diluted you get/how shares outstanding changes as well. So this is I think where the flaw is in my thinking, versus %-age ownership, which is only 1 number to track, which changes over time. But ultimately, all this just seems like a lot of explanation around the exact same thing (which is fine, but I think that’s exactly what was confusing me).

I think the more important/less convoluted point to be made in all this is Aaron’s. I think the REAL dis-service that management does is to give young startup employees the impression that they will get *rich* from working with them. I had this happen time after time, when I was interviewing with prominent VC-backed startups, and it befuddled me. Most FOUNDERS don’t get as rich as they think they might, after taking vc money, let alone startup employees (even in what appear to be successful exits); it’s astounding to me that this “carrot” is paraded around to potential employees. I’ve had CEOs with big-name venture capital experience tell me how “I may never have to work again” after joining xyz corp.; simply worthless.

I think the two biggest motivating factors that went into choosing my current place of employment were:

1) Learning enough to feel comfortable being a founder myself: this was/is my REAL motivation for working at a startup. I have no delusions of getting rich as a startup employee; I am where I am to advance my career, and to learn more than I could anywhere else, so that I can ultimately be comfortable leading the helm, at another company. This was the primary driver in choosing my current employer; however, very few people emphasized this.

2) Being made whole: my all in-comp, if I weren’t @ a startup and in my prior profession, would probably be no less than 3x what my salary is now (roughly). I think that with a moderately reasonable exit, I could make this back. This is somewhat important to me; maybe it shouldn’t be. But it’s nice to think that I might be able to make up my *immediate* financial opportunity cost, if things go at least reasonably decently.

I think #1 is much more important than #2, but ultimately, I think these are the 2 points founders should focus on, when hiring employees; aggrandizing the opportunity to be some kind of “lottery ticket” is the real trickery IMHO.
http://patriceborne.com Patrice Borne

It is a very interesting post and the comments above are all making valid points.

I believe that knowing what percentage of the company your shares represent is the most important number because, when the company matures and, hopefully, either goes public or gets sold to a much larger company with deep pockets, the number that is going to matter will be the total money the company gets sold for. Then, and only then, will the value of each share be computed by using the number of outstanding shares. Obviously, if there is a special provision that says that preferred stocks get special treatment, the commoners will get even less.

The point I would like to make is that you often get an offer along the lines “you get paid less in salary, but you get shares/stock options to compensate. These shares/stock options have the potential to be extremely valuable in the future.” In other words, you are being asked to accept a lower salary in exchange for the potential of selling your equity in the future.

Knowing your likely percentage after dilution in 3, 5 years, or more, down the road is obviously tricky, but one can estimate this number by evaluating the best case scenario (the worst case is that the startup won’t be successful and your shares will be worth 0.) Take the percentage as of the moment you join and assume no dilution at all. Then, estimate what this startup could sell for in the future (use numbers of recent success stories) and figure out your best case payout. Now, take this number divide by the number of years you expect to have to wait before cashing out. Compare this number to the loss of income working for this startup compared to what you could get working for an established company and see if you are willing to take the risk. And remember, this is your best case scenario. You should probably correct this number by dividing it by 2 or 3 to take into account probable dilution. I won’t get into the details of “opportunity cost” and taxes as this would complicate the whole calculation beyond what this discussion is about.

My personal experience is that it is usually not worth the risk, unless you are out of college and have minimal cost of living and can afford a low salary in exchange for a future pay out -or- you are in the founder/executive team and have preferred stocks that guarantee a minimum payout. The commoner will probably simply catch up on their loss of income due to lower wages but they won’t be able to retire…

Also, if someone tries to sell you an offer with something like “we are going to offer you X shares/stock options currently worth $Y based on our latest financing round” be extremely careful. These shares/options are actually worth $0 because they are not liquid and you probably cannot sell them to anybody else.

Now, if you are an entrepreneur, working as a commoner in someone else’s startup in order to build your chops so that in 5 or 10 years from now, you start your own company, that is probably worth it. Know what you are getting into and what your motivation is.
Reid Curley

@Aaron Cohen, AA, Patrice Borne: Bingo.

The sad fact is that you are not going to get rich off options unless you strap onto a one-in-a-million Google-type rocket ship. Even if you are a C-level guy who comes in relatively early and the company is pretty darn successful, the math isn’t all that compelling. Your options represent 1.0% after all the dilution; sell company for $500 million; ignoring exercise price and any funky venture terms, you get $5 million pre-tax; depending on how/when you exercised, holding period, your state of residence and tax rates in effect at the time, you may end up with $3 million in the bank. A nice chunk of change to be sure, but not enough to buy that house in the Hamptons and live a life of leisure among the hedge fund guys.

I am sure things are different in the heart of Silicon Valley, but in my experience, once you are past the raw start-up phase, options are almost never that critical in a non-management hiring process. This may be the real reason that prospective employees don’t ask what percentage of the company their options would represent. The prospective employee just does not attribute that much value to them. Further, once you are beyond 10-15 employees, many people don’t even ask what the number of options they will get will be, let alone what they represent as a fully-diluted percentage of the company. It is a fair question to ask whether companies that are at this stage should be issuing options at all given the administrative costs of doing so.

The other thing that I would point out is that if you are going to educate your employees on how to value their options, you need to give them an overview of the relevant tax provisions. Depending on the individual’s situation, the AMT can pretty much kill the incremental value of an ISO versus a non-qual unless the employee can afford to exercise them before the “bargain purchase” amount gets large (which is rare, particularly given the low wages that the options supposedly offset). So, it is often the case that you are either paying ordinary income tax or AMT on the most of the gain. Just about nobody pays attention to that, even those who know that their x,000 options represent 0.yy% of the company.

Anyone who wants to join a startup and has the options as their most important reason for doing so probably should be screened out in the interview process. I want people who want to work in a dynamic environment where they can do things they couldn’t do at a more established company and everything they do matters to the business.
http://venturehacks.com Nivi

Chris,

Why slag the Venture Hacks?

Before you join a company, you should ask “What are my options worth?” and “What percentage of the company do my options represent on a fully diluted basis?” See http://venturehacks.com/articles/job-offer

We also say that you should “focus on your share price” because the share price and # of shares are the atomic components of a cap table. See http://venturehacks.com/articles/job-offer

In an effort to write punchy articles that grab people’s attention, we tend to over-simplify the conversation:

“The one number you should know about your equity grant” (that’s you)

“Most people think [percentage ownership] is important—it’s not.” (that’s me)

If you’re going to join a company, you should ask a lot of questions, including the percent of the company you’re being granted. Then evaluate the answer in context. For example, later stage companies will give you a smaller percentage of the company.
http://venturehacks.com Nivi

Oops, the second self-promotional link I offered should have been: http://venturehacks.com/articles/share-price
http://anyclip.com Aaron Cohen

Reid:

So there needs to be a greater emphasis placed on the career growth as opposed to the job. Working at Hunch or AnyClip or any of the startups represented in this discussion brings good and bad things. We need to really be transparent about all of that and when we are we retain the people we want most.
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http://www.sanainside.com Diego Sana

This is a great advice, one that indeed every entrepreneur or engineer should get early on their lives. I wish myself that i had received it three years before, when i sold my first startup and got stocks as part of the payment without knowing the percent they represented. This may make me look dumb now, but these things really do happen even with smart and math oriented people, and nowadays it’s clear for me that the acquiring company was not honest.
chris

Nivi – I love venture hacks and think what you guys are doing is great. I just totally disagree with you about the % ownership issue. Every VC and management meeting I’ve been in, everyone talks exclusively about equity grants in % ownership terms, but then suddenly when they talk to employees they switch to $ value to try to make it sound bigger. I think it’s lame.
chris

AA – yes, if you know your number of shares and “fully diluted” (including unissued options) total outstanding shares you can compute your %. But note that management can do a things like raise money, increase option pool size, etc that might lower your % without notifying you. The company I heard about yesterday is telling employees the % and total outstanding are “trade secrets.” Total BS.
Avi

Chris

In theory what you are saying makes sense but you are encouraging something which will lead non-senior employees into a very confusing situation. Most options get offered to non-senior employees and I would suggest that your advice will cause more problems than it will solve.

Examples:

What is the right % for these employees to have? How do I compare a % in one company to what my friend got at another company? How do I adjust for the stage of the company? What employee knows how to negotiate that?

There is no way for them to anchor this around something tangible.

Having been on both sides of this negotiation I feel that as a member of Senior management it is better to negotiate a % because on a dollar basis it always sounds like too high an amount. However, as a junior employee who will receive a fraction of a %, how do you know what to ask for?

Partial Solution: There is a way to anchor this for a company which has recently raised money (as long as there are not large preferences) which is to use the most recent fund-raising price per share as an implied market valuation. Assuming that investors are smart and weren’t duped by management into over-paying, then there is a good chance that a future exit will be at a premium to this.

So actually what I would encourage employees to find out is:
- How many options
- Exercise price
- Price per share paid by the investors
- Did they get any liquidation preferences
- When the investors paid this e.g. pre / post a bubble
- Research the investors i.e. are they likely to have set the price correctly
- Check to see if the management are trustworthy.

This has the added advantage of being translatable into actual dollars paid in options when combined with the vesting schedule. It also automatically adjusts as the value of the company goes up i.e. I get fewer shares which are worth more. In % terms it is impossible to know how to adjust the % as a company gets more valuable.

Overall I think your advice is very misleading and knowing your % provides you no extra information unless you are somehow negotiating the deal based on %.
chris

avi – so you think it’s ethical when an employee asks what % their options represent (or, equivalently, the total fully diluted outstanding shares) to tell them that’s a secret?

If you have CEO/VC experience you know full well everyone on the management/VC side of the table talks about option grants in % terms – why do you think we should then switch into another metric that no insiders use and seems only to exist to make the grant sound more favorable?

I’d agree that all that other information is valuable for the employee as well. But in my mind if management won’t reveal outstanding shares or % they are slimy and shouldn’t be trusted.
http://anyclip.com Aaron Cohen

Chris’ rule shoud be standardized. Reality is people who hear they got a.005% of a company need to realize that without a staggering exit (this is 500k @ a $1bn valuation) that this slug of options indicates they are valued as a solid employee no more and no less. They are probably good but young in a replaceable position. This is reality.

And we should encourage our employees to think about careers and ot getting rich quick off their 1st or 2nd startup (particuarly when they are non-founders)
Joseph Turian

Depending upon whether the company is far enough along that its valuation is meaningful, Venture Hacks recommends you focus on share *price*, not percentage:
http://venturehacks.com/articles/share-price

But your point is taken that share quantity is meaningless in isolation.
Joseph Turian

Chris, interesting retort to the Venture Hacks argument, where you argue that share price is not meaningful either. I hadn’t studied the comments before posting (my mistake).
http://eecblog.com Dave Broadwin

While I certainly agree that an employee should understand what percentage of the company her options represent, I always advise my corporate clients to state clearly and without ambiguity the number of shares that the option permits the employee to acquire. They can then say that this number represents X% of the issued and outstanding as of Y time. Until it happens to you, you have no idea how aggravating it is to be at the closing of a sale of the company to a Fortune 100 buyer for a munificent sum only to have some employee show up with a letter stating that he had been granted $0.10 per share options to buy 2% of the company.
chris

Dave – I totally agree with you. Anytime the % is presented the # of shares should as well, and the fact that they can and probably will get diluted should as well. I also think it should be standard policy to notify employees when they are diluted. My main point here was to argue against the seemingly widespread practice of refusing to reveal % ownership (or equivalently total fully diluted shares outstanding) which I think is deceptive.

Chris Dixon