Ask HN: Exercise Price For Options At A Startup

4 points by scatter 13 years ago | 9 comments

I am considering joining a startup and would appreciate if someone could tell me if I am getting a good deal in terms of stock options.

First a bit of back ground: The start up is related to my PhD research area and gives me a chance to build up on my back ground as opposed to a standard industry job. So, I am considering this seriously.

The company has 1 million stock outstanding with a stock value of ~60$ per share at a recent valuation. The CEO is the majority stock holder in the company ~60%.

I am being offered around 7500 stock options with the strike price at the fair market value (~60$/share). Since the strike price is so high, it basically makes it impossible for me to exercise the options without selling the stock at the same time (when the stock is vested).

Is the strike price for the options normally equal to the current market value or is it usually a discounted price ?

Thanks !

scatter 13 years ago |

Thanks for your replies everyone ! One of my concerns was that CEO has been putting in all the money so far, so the valuation of the company is questionable.

Only comparison I could make was with another competitor in the same area, which is valued about twice of this company. So, the valuation doesn't look too arbitrary.

The good thing is that the CEO has been the CEO of another big company for >10 years. So he is capable of making this company a success. This company has been around for 5 years and has some physical products out there, so the chance of it going belly up over a short period is relatively low.

They are offering a salary that slightly exceeds that job current job including bonus/401K etc. and the vesting period for the options is 3 years with 1/3rd of the options vesting each year.

The CEO wants to make the company profitable and keep it private if possible. He said I could sell the options back to the company once they vest. He said he just converted somebody's options to company's stock once they vested. I am not sure if I can get real cash for the options though, if the company is still private and not seeking funding.

The offer letter says vesting period, but it doesn't give details regarding what happens if the company gets acquired before my options vest.

Is it okay to ask for the options agreement, before joining the company ?

brudgers 13 years ago |

I think this is a case where it's probably best to look at regular compensation and take stock options out of the evaluation. A high strike price and a majority owner who wants to keep the company private mean that there is low likelihood for a significant upside.

After a year you will need to come up with $180,000 to exercise your options. That's real money for a small ownership stake with no control - i.e. it would pave a substantial runway with ramen for your own startup. Sure, if the stock is up above the strike price, you could borrow and then sell for a profit - but that's likely to be in the annual bonus range (a few thousands) rather than home run money.

Two additional pieces of advice: make sure that you understand the tax implications, and be sure to read over any buy/sell agreement carefully.

Good Luck.

scatter 13 years ago | |

Thanks brudgers ! Is it okay to ask for the stock option agreement before joining the company ?

brudgers 13 years ago | | |

Based on not having done so myself in my younger days, I would absolutely require it (in regards to a closely held corporation).

It is not uncommon for the stockholder agreement of a closely held company to require the sale of shares back to the company upon an employee's departure or to prevent the sale of shares to a person of the employee's choosing.

In particular for your case, the agreement will tell you whether the company is obligated to loan you money in order that you may exercise your options so that the stock may be resold back to the company.

The more I have thought about it, the more this looks like a discretionary bonus not really an investment opportunity. The amount of money entailed to exercise your options and retain the stock is just too high - these are option grants which are vesting not stock grants. If at the end of the first year the company doesn't loan you money to exercise your options, there's no value for you unless you have $150k in cash handy.

I would add that 7500 shares is going to require a ten billion dollar exit to give you "fuck you" money (assuming no dilution or liquidity preference). Again it's probably best to ignore the stock as a form of compensation.

[edit] Any resistance to giving you the stockholder paperwork while you are considering the offer is, in my opinion, a red flag.

mchannon 13 years ago |

"at a recent valuation"- is that market imposed or internal to the company? Finding one investor bold enough to put in at a $60 basis is completely different from publicly trading at a $60 basis.

After the company goes through $XX million of funding, gets closer to its goal, but the industry and stock market don't value it, you may have singlehandedly helped it go to $45 instead of $0.01, but you don't make out, period.

My understanding is that you can sometimes sell the option for fair market price once it vests (again, publicly traded at that point?), so worrying about how high the strike price is is the least of your problems with this deal.

These deals often have "vest at the board of directors' discretion", "fire before vesting" and dilution gotchas that leave you holding the bag (an empty bag) when it's time to pay you. Keep a close eye on those.

The reason to issue options at market value is to avoid you getting a tax bill right away (for income you don't get to spend). If you do take the deal, be sure you file the correct tax form immediately to keep that tax liability away.

Hopefully this is a great position with great salary, because at $60 this company's mature enough that without a major breakout and savvy business CEO, the options are lottery tickets.

SimianLogic2 13 years ago |

Seems normal--whether it's a good deal or not depends on where that valuation comes from (in-house or pegged to a funding round), where you think the company will exit, if you think the company will exit, the salary they're offering, and the salary you could get elsewhere.

If they sell for a penny under $60 million, your options are underwater and worthless. If they double in value over the next 4 years (assuming standard vest), that's $450k to you if they sell for $120 million. If they never exit and you leave the company, you're basically screwed (unless you have $450k lying around and are certain it will be liquid again later).

You should make a projection of how you think the company's value will change and weigh that against the salary they're offering. Three-quarters of a percent sounds pretty generous for a startup that's already valued at $60mm, unless you're coming in at a pretty senior level, but without knowing where that valuation comes from it's hard to say for sure.

mchannon 13 years ago |

Since you've mentioned the founder is the source of the $60 valuation, you need to look at the fundamentals of the company to calculate what those options are really worth. (who's the other 40%?)

Figure how many $M in earnings the business has now, 1 year, 5 years, and then multiply that by a P/E ratio, of, say, 20. If you're nowhere near $60M then the founder is not being honest with you (and unfortunately, probably not honest with himself either).

zio99 13 years ago |

Usually current market value. It's discounted if it's considered high risk (and therefore has the possibility to tank).

zio99 13 years ago | |

Can you confirm whether you can definitely exercise the sell? Also, what is the length of the term of vesting? Taking that into consideration; do you see this company around at that time?