I regularly hear people getting excited about having been awarded stock options in their companies, but not having any idea what the value of those options actually are. As a startup CEO, I wanted to write a quick guide for our current and future employees on how stock options work, and give some rules of thumb about how to assign a financial value to your options grants.
Also, this assumes options in a venture-backed kind of company; options in publicly traded companies are a totally different beast. Options in a startup company do a great job of aligning investor, manager, and employee incentives. They can also return life-changing sums of money for employees when things go well.
However, people frequently over-value their stock options, leading to disappointment when and if their company is acquired, or goes public. You need to know both the number of shares you have options to buy, as well as the total number of shares that have been issued for the company.
If a company does this, assume your options are worthless. You have no way of assessing the value of the shares without this information. At MedCrypt , we have about 5. So an employee with options for 10, shares could own approximately 0.
To find your ownership percentage, divide your number of shares by the total shares outstanding. Here is a table showing the relative ownership percentage for an employee with 10, options in a few different scenarios. This can lead to huge disappointment. This means that, if the company is acquired, the preferred share holders each get their initial investment back before any other share holders get a dollar. Here is a table showing the options value for an employee with 0.
This means that you actually have to work for the company for some period of time in order to earn the options. A common vesting period is 3 years for employees.
What if the company sells before your options have vested? That means you need to write a check. If you decide to leave the company, you normally only have 90 days to exercise your options. So much for making up for a lower salary!
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