Stock options: a balanced approach | Hacker News Reader

Stock options: a balanced approach

yosefk.com

70 pointsluu26 comments

A part of the article I disagree with is that I don't see Goldman and BlackRock’s involvement as a good sign. These late stage investors have terms that no employee gets. [1, 2] Employees who joined late are going to get screwed as ratchet clauses kick in. The PE folks are showing themselves to be better negotiators than the founders who focus too much on valuation and the happy path. The large number of unicorns and the numerous late stage deals will probably be one of the notable things about this bubble. It’s the worst of both worlds for employees, no upside of joining early and no government / regulatory protections found in a public market. As more people get screwed we may see a shift from ‘unicorn’ being a positive recruiting tool to a negative, which could push companies to IPO earlier despite the supposed Sarbanes Oxley fears. The brunt of the late stage startup risk is on the employees. The founders have taken money off the table, the VCs have their win, the PE firms have their ratchets, while the employees joining late get a handful of options at a fictional valuation.

[1] http://www.businessinsider.com/investors-who-got-in-square-a... [2] http://www.bloomberg.com/news/articles/2015-11-19/square-emp...

You're assuming all late stage startups have ratchet clauses and using a single tech company (Square) to make your argument against joining any late stage startup.

At a certain valuation, many late stage pre-IPO firms do start awarding RSUs vs. options (i.e. Facebook), which eliminates major downside risk to employees.

If anything, I would be more weary of joining a mid-stage tech startup that is >$1 bil valuation with little revenue, nowhere close to an IPO, and still awarding options vs. RSUs. The inherent risks of other investor clauses (i.e. liquidation preferences) goes to 0 the closer a company is to an IPO.

One big question I didn't discuss is how to evaluate the prospects of the employing company, and I didn't discuss it because I didn't come up with good advice. Companies differ tremendously.

In particular, I personally was spoiled working for a company where the founders are very good negotiators, apparently even better ones than the various i-bankers they dealt with. For instance, they never took any VC money, presumably under the assumption that VCs might decide to gut the company if it doesn't become profitable in a time frame which for them seemed too short. They also made sure to raise tons of money years and years before running out of already-raised money; the conventional wisdom is you're not a bank and you should only raise capital when you absolutely need it, you shouldn't have stashes of idle cash, but the problem with this approach is that you raise money when you're desperate and this diminishes your bargaining power tremendously. Raising money long before it's really needed resulted in really good deals for them.

I was also spoiled working for a company with a simple business model and pretty predictable revenues so it wasn't that hard to put a conservative lower bound on its future value.

Anyway, I only addressed the really wrong arguments that I heard a lot, that after a late-stage investor gets on board the stock "can't possibly rise any more" (meaning, the late-stage investor is at best going to not lose money but can't possibly make any, so they're much dumber than you are); and, "even if it rises, it'll just rise a little" (which neglects the arithmetic of how your capital gain is calculated.) Your argument is different and I confess that I don't have any stats to either support or refute it.

The author makes an interesting point about equity as lottery tickets.

"They call stock options a lottery ticket. I call it insurance. It sucks to have worked at a startup which did make it big and to not have made anything off it. Incidentally, I know quite a lot of people who either forfeited their stock options or sold them very cheaply, on the theory that equity is worthless. Trust me, if you're working for a startup, this is the one accident you want to be insured against."

Calling it "insurance" is probably taking it too far, but there is merit to this analogy, and it certainly is the case that equity is not worthless. With many startups, you can negotiate a decent base salary, and still receive enough equity to make you very well of if the company does take off.

I took away this: if you're neither negotiating a higher salary nor equity, you're setting yourself up for disappointment. Also, always negotiate from a positive perspective. It's much more powerful to say "I believe in this company, I would like more equity in exchange for the value I provide" instead of "I don't believe in unicorns, give me cold hard cash". Especially if you know the extra salary will be hard to come by.

Your mileage may vary. I work at an established company now after a working at a startup where multiple life-saving investment rounds wiped out common shareholders (several times).

IMO, "equity is worthless" is an extreme approximation that is designed to psychologically protect the optimist startup employee from making potentially very poor financial decisions.

Suboptimal, but a decent self protection strategy.

Trouble is, I know a lot of people who used this extreme approximation to their detriment.

In general, there's a huge difference between "worthless" and "cheap". If it's cheap, you might want to get more of it - and then it's valuable. If it's truly worthless, getting more does not help. That's how multiplication works with small numbers and with zero. Zero is a special small number.

So I claim that "equity is cheaper than they make it sound" is absolutely the right thing to say to yourself (not to the employer), while "equity is worthless" is a terrible thing to say to yourself if you then stay at the place. (It's potentially a sensible thing to say to yourself if you intend to leave, and especially if you're leaving for something that looks both good and not that risky.)

The point of insurance is to decrease volatility. Stock options do the opposite of this. I don't understand how this comparison makes any sense.

I wouldn't say there is any singular "point" to insurance such as "decreasing volatility". People buy insurance for multiple reasons.

If a couple buys "trip insurance", it's more about managing risk and uncertainty so they can sleep at night if their cruise ship is cancelled rather than smoothing over price volatility.

Also, I'd just read the parent's quote about "insurance" as a rhetorical device[1] rather than some rigorous financial instrument. The author thought of SOs as "insurance" against missing out on potential upside.

[1] both "insurance" and "lottery ticket" to describe stock options are analogies/metaphors

> If a couple buys "trip insurance", it's more about managing risk and uncertainty so they can sleep at night if their cruise ship is cancelled rather than smoothing over price volatility.

To rephrase, they're definitely paying a small amount of money to avoid maybe losing a large amount of money. That sounds like the definition of decreasing volatility to me.

This is not correct. Stock options can decrease volatility and serve as insurance against large increases or decreases. That is the point of hedging.

For example if I have 100 shares of AAPL @108 and I'm nervous of it dropping below $80 in the near future, I may buy a MAR16 put option at $90/share for a few pennies in the hopes that if the stock does actually decrease to a level that makes me feel uncomfortable, the options will increase enough to offset the stock loses.

So they very much can be insurance. It just depends on how you play them.

Your comment makes sense if you're talking about using publicly-traded derivatives to hedge long or short positions in a diversified portfolio.

The comment to which you replied was talking about employee stock options, which are not generally used to hedge a short position, and often represent a large part of someone's overall wealth and/or income.

Sorry, I was unclear. As a sibling pointed out, the question at hand is private employee stock option grants, which act as a lottery ticket because they are usually worth nothing but sometimes worth a very large amount if the company goes public or gets bought.

You are of course correct that stock options on the public market are most often used to hedge and thus they do act like insurance. It seems fairly certain that this is not what OP had in mind, though.

I like to think of equity as a "buyout bonus" - it's nice, sure would like to get more of it, but not something to plan for as there are just so many aspects of it out of your control.

Maybe the community needs to de-conflate positions (the options) and strategy (lottery ticket, insurance, etc).

If you think your options will be worthless at time 0, why would you join the company?

The right mindset IMO is to only join a company you think will make it big but be prepared to accept fate if it doesn't and your options are made worthless.

A million times yes. So obvious and yet I don't remember seeing this once in the last batch of stock option posts.

My personal favorite signal: there has to be some number of people that are saying 'I LOVE your product!' Similar to what Paul Buchheit says on many people liking vs some people loving your product.

I love neither Windows nor MS Office, but I paid handsomely for these. Also, I don't know people who particularly love to integrate an ARM core into their chip, and I doubt that Apple, Qualcomm, NVIDIA etc. etc. love to pay $30M for an ARM architecture license which gives them the privilege to then reimplement the core themselves, but they all pay up.

On the other hand, I love independent animation, but I don't pay that much to creators and the average independent animation lover might pay less than me. I also love vim (perverse, I know) but I wouldn't pay for it what I pay for Office (Office opens documents that nothing else does and that I must open, while text files can be edited in endless free programs.)

This goes to show that love and money don't always go hand in hand, and is an example of the more general problem with picking winner companies: they're all very different. That's why I didn't say much about it: it's very hard to give good, general advice on this. (And if I could give such advice, I'd be off investing in companies with no time left for blogging.) That said, someone contemplating to work for a specific company might research that company and come up with specific reasons to like it; a bit like how you can prove that a given program terminates even though you can't generalize your strategy for an arbitrary program.

Compares working at Google to a startup in Israel. States "... prices aren't much lower overall, AFAIK" then writes another 2000 words to justify his position.

http://www.numbeo.com/cost-of-living/compare_cities.jsp?coun...

    Consumer Prices in San Francisco, CA are 25.44% higher than in Tel Aviv-yafo
    Rent Prices in San Francisco, CA are 213.57% higher than in Tel Aviv-yafo
    Groceries Prices in San Francisco, CA are 69.48% higher than in Tel Aviv-yafo

From your link:

Local Purchasing Power in San Francisco, CA is 17.10% higher than in Tel Aviv-yafo

That's basically what matters. And 17% is not a huge difference. "Prices" might have been the wrong term to use - but "Purchasing Power" is comparable.

Highlighted, with a box around it, and at the very top of my link:

"You would need around 31,022.61₪ in San Francisco, CA to maintain the same standard of life that you can have with 17,000.00₪ in Tel Aviv-yafo (assuming you rent in both cities)."

Actually I compared working for Google or for a startup in the US to working for Google or for a startup in Israel.

Regarding your point, the difference in prices is not nearly large enough to wipe out the difference in the amount saved working for Google in the US vs working for Google in Israel.

I'm really curious about

> I do know people who managed to find an outside investor who helped them buy their stock options

Is this a common thing?

That's what the company Second Market does, and with recent changes in regulation, we'll see a lot more of these.

http://esofund.com/ does this. It is getting common. With sky-high valuations, the Fair Market Value (FMV) for many startups stock are very high. Although the percentage returns on this might be high, an average engineer needs large amount of cash to play this game. Some firms have come up which help with the "seed" money.

I've done it, but my options agreement with the company put such restrictions on trading the stock that it couldn't have happened without the very willing participation/assistance of the execs. I don't actually understand all of the details, but I know there were issues with both right of first refusal and also prohibitions on private stock transactions that the company had to explicitly waive. In the end, I just had to trust a lawyer to reassure me that in the end, I would no longer have any options but I would have a whole bunch of cash, because all the mechanics were both over my head and arranged by someone else.

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