I know it's hip with the kids to be cynical these days, but surely you jest...
> It's a piece of paper
The legal term is "contract."
> This price can be higher or lower, you cannot know beforehand.
Yep. That's kind of the point. Risk versus reward and all that.
> It's not a replacement for a salary or a stake in the company.
Not directly, no. Neither is health insurance, 401k, company provided meals or other benefits, but all of these things are perceived by most to have at least some marginal value.
> I was handed out stock options myself for a company in the past but it wasn't worth it to use them.
C'est la vie
> I mean, unless you have options from a unicorn, those don't amount to much.
Or, ya know, you end up with a company that has good growth potential and those options work out in your favor, which is actually typically the case btw. On average, the market has improved over time. I'm guessing you were burned either b/c the company was high risk (which means you had the potential to do VERY well conversely) or you were hit by the downturn which also affected almost all stock, so not really related to options in that case.
> I have this impression that some misrepresent options with stock
Then some are idiots for agreeing to something they don't understand.
I've seen so many startups' career pages mention stock options as noteworthy alongside perks. Stock options are like a reservation at a poker table where you're allowed to join the game.
> agreeing to something they don't understand
it's more likely the bling of a startup overshadowing everything and that it's mostly less experienced and young people.
> "Not directly, no. Neither is health insurance, 401k, company provided meals or other benefits, but all of these things are perceived by most to have at least some marginal value."
Stock options are, 99% of the time, worth $0. Perks, benefits, retirement options, all have intrinsic monetary value.
They are also, 1% of the time, worth >$100K.
Some people have a tough time valuing volatile assets and end up making statements like this.. "they're not really worth anything" or "treat them like they're $0". But it's utterly wrong to say they have no intrinsic monetary value. It's more correct to call them volatile assets -- or even more correctly, a risk-free (in terms of capital) option to purchase a volatile asset.
In an existing public company, as someone pointed out, the value of the company should be captured by the stock price, according to the efficient market hypothesis. As such, if the price is just as likely to go down as to go up, this should mean that stock options are merely worthless 50% of the time. Before you get into your ability to choose the sale date (subject to trading windows).
So really, unless your public company ONLY goes down from the date you start (excepting really weird scenarios where it goes up, but is always negative relative to your strike price during trading windows), you stand to make money from your options. Maybe not much, but something. And you can't LOSE money from them, unless you do something stupid related to taxes, or something stupid like buy-and-hold. (buy-and-hold for certain values of 'stupid'; I actually did this once in order to swing a lower tax rate and it happened to work, but I could have lost my proverbial shirt).
absolutely does not apply in private-company stock.
As I mentioned, in a private company, it could well be possible that 99% or 97% or whatever of stock options prove to be worthless.
Typically the case? I'll wager that greater than 70% of startup employee options never pay out.
If you don't want to take this risk, choose a different industry. Traditional corporations issue options all the time that pay dividends that consistently net positive value. You may only get a few hundred/thousand per year, but you can depend (somewhat) on the income they generate.
now, if one really is a 'key player' and a 'cornerstone', then equity is where the game's at.
And for a good rest of the other 10%, you'd have been better off investing in something else.
The point of options is to take on some risk in exchange for bigger reward. To do this you can't come in with an employee mentality of wanting to get a market salary and have a lot of security, you need to start thinking like a business owner. It's easiest to do this as a founder where you have true control, but it's also possible to do so as an early employee / late co-founder, but in that case you have convince the founders/board of your value. Taking a lower salary in exchange for more equity is a concrete demonstration that you are thinking about the company's burn rate, and that you believe in your ability to help the company succeed.
None of this is to justify founder's taking advantage of early employees, by all means stick up for yourself and know your value, but recognize that a computer programmer is not worth $100k a priori, you can spend all your time building things which are worthless. The trick with a company is figuring out how to turn that energy into business value. Founders take on the biggest risk of making that happen, and likewise they get the greatest control. Options with a vesting cliff are the mechanism for realizing that value creation, and rewarding an effort over time.
Your ability to succeed with options will certainly be some amount of luck, but to maximize your chances you need an appetite for risk and the desire to build a great company rather than join a great company.
Here's another: Startups can get in trouble for selling stock to people who aren't 'accredited investor' (basically means "already rich"). This is changing, but it's still a problem.
So for instance, an employee that gets a big pile of options in an illiquid stock doesn't necessarily experience a taxable event. This is good for the employee.
If the stock later becomes liquid and worth a lot, the employee can exercise the options and cover any taxes by selling the resulting stock.
So the time I was a founder and got 100k options at 1c I bought the stock and started the capital gains clock ticking (but then lost the $1k when things crashed and burned). But when I got 10000 options at $1, I didn't buy them for $10k, but made $250k when the company went public -but paid tax at my marginal rate (43% in CA).
You have to make choices depending on your circumstances and tolerance for risk
The problem is equity is serving two purposes. On one hand, it represents ownership of the company, the ‘capital’. On the other hand, due to it’s favorable tax treatment, it has become a key component of compensation.[1] Marisa Meyer didn’t start or invest in Yahoo, but she is compensated almost $40m a year in equity, over 90% of her pay package.[2]
When you are evaluating an offer between a startup and a larger company, regarding compensation you need to evaluate the whole package: salary, equity, and bonuses. Startups want to compare only salary and over value their equity. “You’re taking a 50% pay cut from Google, but we are giving you XXX in equity at our last valuation.”
Look at the total pay packages with more realistic valuations such as a 409a for startups, and then examine the probability of different exits and how much you will make. There’s a reason people say employees are learning while founders are earning.[3] An honest assessment of the paydays doesn’t usually bode well for employees at startups. If founders can’t talk to you about this, you probably don’t want to follow them. Most hope you don’t ask the questions and then say things like “What, you don’t believe in the company!” They should be able to sell you on the probability of success, the learning, and everything that will make up for less comp. But don’t let them mislead you about the comp.
[1] https://medium.com/the-wtf-economy/what-paul-graham-is-missi...
[2] https://www.google.com/search?q=marissa%20mayer%20compensati...
[3] https://bothsidesofthetable.com/is-it-time-for-you-to-earn-o...
A friend of mine works in one of those unicorn startups, and got about a million dollars worth of options at the current valuation. The strike price is about a third of that price. So if she ever wanted to exercise them before the company goes public, she'd have to pony up over 300K (which she doesn't have) and then deal with the taxes. So even if the payday was real, it still means handcuffs until the company goes public, and companies are taking longer and longer before they go public.
So, in practice, regardless of whether her employer will be a successful company in the long run, just being stuck in a job for X number of years before any of that money is real is a big discounting factor.
I think this is a big limitation for those very large startups when trying to hire senior engineers: The risk one takes with RSUs is so much lower the risk with options in a company that has no plans to go public in the next couple of years, it makes so much more sense to work for the publicly traded company.
1. http://blog.triplebyte.com/extending-stock-option-exercise-w... 2. http://blog.samaltman.com/employee-equity
And I doubt all that many options holders confuse them.
And I strongly suspect that the most common beneficiaries of stock options are not those who make millions off of a unicorn they started working at in the early days, but those who pull in a few tens or hundreds of thousands of dollars from stock options over the years at growth companies.
Not every company is trying to time their IPO for the peak of market speculation and then go out of business a year later.
Since they're apparently worth nothing to you, I will buy all your options for $100.
This makes your plan quite a bit complicated and likely impossible to pull off.
In reality, various contracts could be put in place such that I provide $100 now in exchange for the rights to any eventual profit from his options.
To make them more compelling than stock grants the options have to be ISOs, the spread on them has to be negligible or zero (to avoid a large AMT bill), the exercise cost has to be low enough that you are ok with handing over that amount of money up front, and you need to be able to actually hold the actual stock for long enough (at least 2 years from date of grant, and 1 year from date of exercise, to be counted as long-term capital gains).
Note that on this last point if the company is acquired prior to that date you're likely SOL on the tax advantages. These days I much prefer RSUs. I've twice failed to reap the theoretical tax benefits from ISOs due to acquisition prior to the 2 year window, and I find RSUs much easier to reason about especially once option exercise costs become non-trivial (which is the case if you were to join many of the hot pre-IPO unicorns these days).