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In April 2012 I wrote a post titled The 12 Crucial Questions About Stock Options. It was meant to be a detailed list of option-related questions you’ve to ask when you receive an offer to join a private company.

Based on the outstanding feedback I got from our readers on this and succeeding posts about options, I am now broadening the original post a bit. I’ve actually done simply a little upgrading and posed 2 new concerns – hence the slight title change: The 14 Crucial Questions About Stock Options.

Next time somebody offers you 100,000 choices to join their business, don’t get too thrilled.

Over my 30-year profession in Silicon Valley, I’ve actually watched many workers fall under the trap of focusing on the number of alternatives they were provided. (Quick definition: A stock option is the right, however not the commitment, to purchase a share of the company stock eventually in the future at the exercise cost.) In reality, the raw number is a means that business use staff members’ naiveté. What truly matters is the percentage of the business the options represent, and the rapidity with which they vest.

When you receive an offer to join a business, ask these 14 concerns to ascertain the attractiveness of your option offer:

1. What portion of the business do the alternatives offered represent? This is the single essential problem. Undoubtedly, when it pertains to choices a bigger number is better than a smaller sized number, however percentage ownership is exactly what really matters. For instance if one business offers 100,000 alternatives out of 100 million shares impressive and another business provides 10,000 choices from 1 million shares impressive, then the second offer is 10 times as attractive. That’s right. The smaller share offer in this case is far more attractive because if the company is acquired or goes public then you’ll be worth 10 times as much (for anyone doing not have in sleep or caffeine, your 1 % share of the business during that latter offer defeats the 0.1 % of the former).

2. Are you consisting of all shares in the complete shares outstanding for the purpose of calculating the percentage above? Some business try to make their offers look more attractive by determining the ownership percentage your offer stands for utilizing a smaller sized share count than what they could. To make the percentage seem larger, the company couldn’t include everything it ought to in the denominator. You’ll wish to see to it the company uses completely diluted shares exceptional to calculate the portion, consisting of all of the following:

  • Common stock/Restricted stock units
  • Preferred stock
  • Options outstanding
  • Unissued shares continuing to be in the options pool
  • Warrants

It’s a huge red flag if a prospective employer will not divulge their number of shares outstanding once you have reached the offer stage. It’s normally a signal that they’ve something they are trying to hide, which I doubt is the sort of company you wish to work for.

3. What’s the market rate for your position? Every task has a market rate for income and equity. Market rates are typically determined by your task function and seniority and your prospective employer’s variety of staff members and place. We developed our Start-up Wage and Equity Payment Device to assist you determine exactly what comprises a fair offer.

4. How does your recommended option grant compare to the market? A business generally has a policy that places its alternative grants relative to market averages. Some companies pay higher wages than market so they can provide less equity. Some do the reverse. Some give you a selection. All things being equal, the even more successful the company, the lower percentile offer they’re typically willing to provide. For example, a business like Dropbox or Uber is most likely to provide equity below the 50th percentile due to the fact that the certainty of the reward and the most likely magnitude of the outcome is so terrific in terms of absolute dollars. Simply because you believe you are impressive doesn’t indicate your prospective company is going to make an offer in the 75th percentile. Percentile is most figured out by the employer’s attractiveness. You’ll need to know what your prospective company’s policy is in order to assess your offer within the appropriate context.

5. What’s the vesting schedule? The normal vesting schedule is over four years with an one-year high cliff. If you were to leave prior to the high cliff, you get nothing. Following the cliff, you right away vest 25 % of your shares and afterwards your alternatives vest monthly. Anything apart from this is odd and should trigger you to question the business further. Some business might ask for five-year vesting, but that must give you pause.

6. Does anything take place to my vested shares if I leave in the past my entire vesting schedule has been completed? Typically you get to keep anything you vest as long as you exercise within 90 days of leaving your company. At a handful of business, the company deserves to redeem your vested shares at the exercise cost if you leave the business before a liquidity occasion. In essence, this means that if you leave a business in 2 or 3 years, your choices are worth absolutely nothing, even if a few of them have actually vested. Skype and its backers came under fire in 2012 for such a policy.

7. Do you permit early exercise of my choices? Enabling workers to exercise their choices before they’ve actually vested can be a tax advantage to workers, due to the fact that they’ve the opportunity to have their gains taxed at long-term capital gains rates. This feature is generally just provided to early staff members due to the fact that they’re the only ones who can benefit.

8. Exists any acceleration of my vesting if the business is obtained? Let us state you work at a business for two years and afterwards it gets obtained. You may have signed up with the personal business because you did not want to work for a huge business. If so, you’d probably desire some acceleration so you can leave the company after the acquisition.

Many business likewise offer an extra 6 months of vesting upon acquisition if you’re fired. You wouldn’t want to serve a jail sentence at a company you are not comfortable with, and, of course, a lay-off isn’t uncommon after an acquisition.

From the company’s perspective, the downside of providing acceleration is the acquirer will likely pay a lower acquisition cost due to the fact that it might need to release even more alternatives to replace individuals who leave early. But acceleration is a prospective benefit, and it’s an actually good thing to have.

9. Are options priced at fair market value determined by an independent appraisal? Exactly what’s the exercise price relative to the price of the favored stock provided in your last round? Venture capital-backed startups issue choices to workers at an exercise rate that’s a fraction of exactly what the investors pay. If your choices are priced near the value of the preferred stock, the choices have less value.

When you ask this concern, you are trying to find a big price cut. However a price cut of even more than 67 % is most likely to be looked upon unfavorably by the Internal Revenue Service and could lead to an unexpected tax liability since you’d owe a tax on any gain that arises from being provided choices at an exercise cost below reasonable market price. If the favored stock was provided, say, at a value of $5 a share, and your alternatives have an exercise cost of $1 per share vs. the reasonable market price of $2 per share, then you’ll likely owe taxes on your unreasonable benefit – which is the difference in between $2 and $1.

10. When was your proposed company’s last typical stock appraisal? Just boards of directors can technically provide choices, so you’ll usually not know the exercise price of the options in your offer letter till your board next fulfills. If your suggested employer is personal then your board has to determine the exercise cost of your alternatives by exactly what’s referred to as a 409A appraisal (the name, 409A, comes from the regulating section of the tax code). If it’s been a long time considering that the last appraisal, the company will have to do another one. Most likely that means your workout price will increase, and, correspondingly, your alternatives will be less useful. 409A appraisals are usually done every 6 months.

11. Exactly what did the last round value the business at? The value informs you the context for how important your alternatives can be. Typical stock isn’t worth as much as preferred stock till your business is gotten or goes public, so do not succumb to a sales pitch that promotes the value of your suggested options at the most up to date preferred cost. Again it’s a huge warning if a prospective employer won’t disclose the appraisal from their funding once you’ve actually reached the offer stage. It’s normally a signal that they’ve something they are attempting to conceal which I doubt is the kind of company you want to work for.

12. How long will your present funding last? Additional financings imply added dip. If a financing looms, then you’ve to consider what your ownership will be post-financing (i.e. consisting of the new dilution) to make a fair comparison to the marketplace. Refer back to question number one for why this is important.

13. How much cash has the business raised? This could appear counterintuitive, however there are numerous instances where you’re even worse off in a business that’s actually raised a lot of cash vs. a little. The issue is among Liquidity Preference. Venture capital investors constantly get the right to have very first call on the earnings from the sale of the business in a downside scenario approximately the amount they’ve actually invested (simply puts concern access to any profits raised). For instance, if a business has raised $40 million dollars then all profits will go to the investors in a sale of $40 million or less.

Investors will only transform their preferred stock into usual stock once the sale evaluation amounts to the quantity they invested divided by their ownership. In this example if investors own 50 % of the business and have invested $40 million then they will not convert into typical stock up until the company receives an offer of $80 million. If the business is sold for $60 million they’ll still get $40 million. However if the company is sold for $90 million they’ll get $45 million (the remainder goes to the founders and staff members). You never ever want to join a company that’s actually raised a lot of cash and has very little traction after a few years due to the fact that you’re unlikely to get any take advantage of your alternatives.

14. Does your potential employer have a policy concerning follow-on stock grants? As we explained in The Wealthfront Equity Plan, enlightened companies comprehend they’ve to issue additional stock to staff members post-start-date to deal with promotions and extraordinary efficiency and as a reward to keep you once you get far into your vesting. It’s very important to understand under what condition you may get additional options and how your total options after four years might compare at companies that make contending offers. For more perspective on this issue we urge you to read A Worker Viewpoint on Equity.

RSUs

Almost every issue raised in this post is equally pertinent to Restricted Stock Units or RSUs. RSUs differ from stock alternatives because with them you get value independent of whether your company’s company value increases or not. As a result staff members tend to be provided less RSU shares than they could get through stock options for the very same job. RSUs are usually issued in circumstances when a prospective company has recently raised money at a big evaluation (well in excess of $1 billion) and it’ll take them a while to become that rate. Because case a stock alternative mightn’t have much value because it just appreciates when and if your company’s value increases.

We hope you find our new and improved list valuable. Please keep your feedback and problems coming and let’s know if you think we missed out on anything.

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