The Guide to Stock Options Conversations
zaidesanton.substack.com
zaidesanton.substack.com
That's the whole magic trick. Come work for us! We can only pay $50k in boring everyday money, but here's some tokens. We don't know what they're worth, and you can't spend them for many years or maybe not at all, but look at this picture suggesting they might be worth lots! Works really well on people new to the workforce.
Actually giving employees a means of valuing it, notably that their options turn into a class of shares that get paid after lots of other people and a sketch of how dilution works out in the meantime, stops them thinking it's a lottery ticket. It becomes a very low chance of winning less money than the opportunity cost relative to working elsewhere.
Much more fun for employees are RSUs. They have the same nice trick of becoming free when people quit. They let you adjust people's pay without annoying them as much as a salary freeze or reduction. A three or four year vesting period with roughly annual grants is near perfect as a salary retention tool.
Also rsu induced pay inflation has really hurt the startup recruitment pitch which helps defang an existential threat to your public company.
Not really what I want as an engineer but the incentive gradient is very clear.
If I have to be short theta, at least be a [company] man and make it something like 75-delta >720 DTE calls. Ideally let me sell 50-delta <360 DTEs to the new on-boards as well! :^)
Long longer dated ITM calls protect downside in IV spike, and being short shorter (relatively) dated ATM calls pays me more theta than I pay for the ITM while the ITM gives me much needed vanna if the underlying shits the bed on my spread (assuming skew exists).
One is very early, iff the startup supports early exercise. Join, immediately do an early exercise of all your options and file an 83(b). This only makes sense if you join so early that you can afford to exercise all those options for an amount of money that you won't mind losing if the company goes nowhere. Typically this only makes sense if the exercise price is in the few pennies range (but depends on your finances). So before a series A at the very latest.
This is good because you can now work there are long as you want but you are also free to leave if things become unpleasant. As long as you spent at least a year there, any shares you vested prior to leaving are yours for good. If the company IPOs many years after you leave, you still get something.
The other good time is when the company is already large and well-known and clearly on the path to an IPO. You'll get far less ownership obviously, but probabily of success is much higher.
The worst time to join a startup is anywhere in between. The exercise price of your options is too high on day 1 you can't afford to buy them, then you work there for years and become vested on paper but can't do anything about it, then you leave prior to an IPO and you still can't afford to buy the options so they cancel and you are left with nothing.
I've done each of these scenarios, some more than once.
Angel investing is extremely risky, and converting options is riskier than that! Common shares are much much higher risk than preferential shares.
Plus diversification is good. Concentrating your assets and job into one investment is speculation: great when you win but terrible when you lose.
I reckon we are conceited to think we can invest smarter than professional VCs? They lose all the time even though it is their fulltime job and they are insiders on the rules of the game.
If your prior is: exercise price and Fair Market Value are equal, my bet would be that the shares are most likely loser shares.
Winning shares are much more likely to have a fair market value that exceeds the option exercise price.
The rules of the game are written by the winners!
You can't have that, options can't be granted below FMV.
See e.g.
https://rsmus.com/insights/services/business-tax/stock-optio...
"The exercise price may never be less than the fair market value (FMV) of the underlying stock on the date the option is granted."
If you are able to early exercise, the exercise price and the FMV can be the same though. Which is ideal since the taxable delta is then zero and you file the 83(b).
I'm left with the sense that this is a response to some other post, not mine?
To be clear, I'm talking about scenarios where one would join a startup as a regular employee. Not talking about angel investing or anything like that.
Common shares have zero value until after the preferential shares are in the money. i.e. buying common shares is as risky as investing in call options.
Angel investing is extreme risk, call options are extreme risk, and as a sweeping generalisation: common shares are riskier than those. I'm only mentioning Angel investing because we all know how risky that is, so it is a baseline to compare against.
You answered JonChesterfield who's point was "here's some tokens". Your reply is entirely sensible and you are rightly saying those tokens can end up winning and you explain a good strategy to get valuable tokens and gamble some of your pot.
I am attempting to amplify JonChesterfield's comment, perhaps I'm failing!
Aside: I really appreciate your comment and I am commenting to help my own thinking. I have been trending towards doing Angel investments which requires understanding VC incentives. I'm past being an employee so I'm not sure how relevant my comments are to anyone! VCs and the VC ecosystem use the confusion between the details of public market shares, common shares, and preferential shares to the advantage of the VCs.
> If exercising your shares is a trivial cost, then it doesn't matter.
Well yes, that was my point. That's why you'd ideally join very early, so you can early exercise and buy all the options up front for very little money.
This article argues the opposite using financial arguments: https://www.investopedia.com/articles/optioninvestor/09/get-...
It is a bit technical for my level of ignorance: and it seems irrelevant.
Interesting how it points out that companies get a financial advantage on their books if you early exercise.
I think it is saying that optionality has a value to the person that owns the option and that early exercise loses that value.
I think you are saying that in the winning case, you are better off if you have exercised early. Perhaps you are not costing the losing case properly? Lottery tickets!
Thank you. I appreciate learning from you and I hope I have learnt something from that article which I wouldn't have done otherwise (even if I don't understand the pricing details).
My eyes tend to glaze over whenever volatility is mentioned. Relevant to public stocks and options in public markets. I suspect volatility is not a useful measure looking at investing in early-stage startups since value tends towards all or nothing. The distribution of returns for a single startup seems fairly wacko - hard to model.
That's why I'm emphasizing the part about joining very early. Early exercise is ideal when you join when the stock is worth basically nothing, but doesn't make sense later in the startup's life. Which is why in the original post I say that IMO you don't want to join a startup in the middle of its growth. Only very early, or very late.
For example: I joined one very early startup where my option price was a small fraction of a penny. I early exercised and bought many hundred thousand shares for less than $20. There's no downside, worst case I lose less than the price of lunch.
The other reason to early exercise is freedom. You can leave without angst about losing your unexercised options. There are no golden handcuffs, you're free to move jobs.
Right. This is what has confused me. I had presumed that the options were a much more valuable part of your pay package (like tens of thousands to exercise early).
Yeah, $20 is a good price for a lottery ticket!
I would presume few VC run companies would give away shares that cheaply now?
You have to join early, before VCs get involved. After a funding round prices spike 1000x or more.
> options were a much more valuable part of your pay package
This sort of makes no sense. Options are not part of the pay package per se because they are worth nothing. In some far future they might be worth something (or rarely, a lot).
And choose to be an early employee at a place that somehow gets a 1000x valuation boost between Angel and Round A. $100k would be a small Angel round so round A would be $100 million (rather an outlier). 1000x boosts are simply not easy to find.
Your facts just don't line up: if you got lucky then your advice simplifies down to "get lucky".
The language you use to describe option grants suggests you haven't. A startup does not "sell shares" "ridiculously cheaply". They grant options and the valuation is what it is at the moment.
Here's an article that might help:
https://startuplawyer.com/incorporation/par-value-for-a-star...
Note this quote: "I typically recommend that a startup corporation’s Common Stock par value be set at $0.00001 and no higher than $0.0001 per share."
You are correct that I'm unfamiliar with employee options: that is why I'm asking what you are saying because it just doesn't make any sense to me (looking at it as a founder). I'm trying to understand but failing and your explanations feel to me like they go left-field every time.
The VC culture here is rather thin and options are not commonly used.
> par value be set at $0.00001 and no higher than $0.0001 per share
Sure, that is at inception. If you are getting shares at inception you are one of the first employees. One Angel investor and the shares get a valuation and that valuation is nothing like par value. Money for early employees often comes from investors. I guess the founders could be paying you but that would be less common.
When your options convert you pay the option strike price, not the par value. Setting the options at a price close to par would be extremely strange because they would dilute the founders.
I guess I'm saying that I don't understand because the financial incentives seem wrong and everything you've said doesn't seem to fit together to me: including your comment on par value.
"The exercise price may never be less than the fair market value (FMV) of the underlying stock on the date the option is granted."
Fair market value shouldn't be anywhere near the initial par value (unless the business is close to worthless).
I guess it could make sense if the founders decided they were giving you x% of stock, and they used options as an intermediate step to do that for some reason (e.g. vesting).
Yes. Going back to the very top of the thread, that's what I said. The best time to join a startup is very early (or very late).
> (unless the business is close to worthless)
Yes. A new startup is basically worthless, it's just a piece of paper and they haven't built anything yet. That's a good time to join.
> I guess it could make sense if the founders decided they were giving you x% of stock, and they used options as an intermediate step to do that for some reason (e.g. vesting).
Yes, of course. That's literally what joining a startup is all about!
I guess the market is different in NZ. You said "The VC culture here is rather thin and options are not commonly used."
It is all about the options in the US (or SV at least). If founders didn't give you x% of the company via vesting options, why would anyone ever join a startup?
Hedge with far OTM (1-5 delta?) LEAPS puts in same-industry/sector competitors or market indices? At least reduce some crash risk, though I am not sure how you run your stock options compensation through BSM without a market to price against. Probably should figure what your VaR is for an x-sigma crash and try to get a hedge which will roughly balloon to that level under high vanna.
The post itself provides ample evidence for why this is a rational position, especially for people with even mild risk aversion.
For instance, look at the table of "Startups that exited for more than they raised." Even among those who raised a Series E or later -- the most likely to exit -- only 40% experienced a favorable exit, and among those, the mean valuation growth was 2.26X.
Under optimistic assumptions, that's a "double your money" scenario with 40% odds, which is a not even a great bet in the aggregate -- but a pretty terrible bet for any individual.
Financial advisors counsel people all the time not to put their eggs in one basket. That's why index funds like VTI are so popular. They let you diversify your investments.
Heck, putting so many eggs into the basket of your employer is risky even after it goes public! I had a publicly traded employer who had a 401(k) match paid in company stock. Every pay period, I sold that stock and bought index funds instead.
It’s hard to trade in somewhat certain money for likely fictional Stock Options. Though I’d possibly trade RSUs from company A for company B.
There’s almost like a two tier employment system between those at FAANG or adjacent with actual likelihood of a healthy payout and those with options / lottery tickets.
I did the same thing. The options were from a company that had just IPO'd named Google. You may have heard of it. ;-)
This is also the calculation for an investor, and is not really relevant for an employee option holder.
VTI carries the risk that your investment could lose value in the short term, but over a longer time period, I'll take VTI over stock options any day.
One nuanced take that I've found useful: diversify to preserve wealth, but concentrate to build it.
To be clear, I'm not advocating against the default view that stock options are lottery tickets, because from a pure financial point of view that's close enough to the truth. However, it's important to understand that outlier wealth comes from ownership of businesses, and the whole point of being at an early stage startup (whether as founder or early employee) is to be an agent in the success of an outlier business.
There's no way around the fact that this is a fundamentally risky proposition. The odds are always against you—especially given how much one can make in FAANG, it's a particularly difficult time to make any kind of expected-value argument for working at a startup. That said, there will be more outliers in the future. Many people who work on those will see generational wealth far exceeding the rank and file of FAANG. They will have gotten there via a drive to do something new and different, and working together to achieve something that the majority of rational people deemed impossible. Despite future dismissals about luck, or odds, or averages, or reproducibility, noone can take away what they will have accomplished through the sweat of their brows and choices made along the way in the face of massive uncertainty.
Ultimately, the best reason to join (or found) a startup is because you really want to try to do a hard thing with a group of people you trust and admire enough to go into the trenches with for the next 2-5 years. It can pay off, but the mentality necessary for success is diametrically opposed to good financial advice.
This kind of advice often assumes that it is easy for anyone to get a FAANG job. I got rich from a startup, before that I was working for a bigger companies and I'm very sure that I would never have been successful in that game. I'm fairly sure that corporate jobs work out for quite different persons.
In the United States, this is not just unnecessary secrecy: this is completely illegal. Trying to forbid employee-to-employee conversations about compensation will land the company in trouble, and every manager should know this.
I understand this to be a fairly common experience in the U.S. workforce.
When it comes to labor laws in particular, the rate of enforcement is extremely low.
You agreed to the pay. Want more? Ask more. If you're making 2x more than your "peers" would you take a cut to equal pay?
Information is missing on both sides.
Contracts are open with all Information available. To that route if you're wanting to make more than the W2
Knowing salary is also useful for existing employees, and in that case (in the US) the employer likely does know all of those things.
If I’m paid twice that of my colleagues, I’d want to support them (unless they’re detrimental to my job satisfaction) in getting paid more so that they’re less likely to be recruited away purely for financial reasons. I’d also be concerned about the future projection of my own comp.
However, I'm all on board with the idea that people who do want to exchange this information should be free to do so without punishment from their employer.
Follow-up email: "Thanks for the helpful feedback in the review! And yes, as instructed, I would never dream of talking to co-workers about compensation. I know that's against policy."
Then, either he puts in writing that it's not policy, or you've started a paper trail.
What I've seen work well is the company taking pro-active steps to be transparent about compensation in aggregate. For example, HR can put out a periodic report documenting compensation metrics by job title and experience. They can also slice the data along various social factors to quantitatively show whether there's any indicators of unintentional bias. From there, another good idea is for the company to regularly apply adjustments independent from performance, in order to keep the metrics healthy.
It's fairly useless to have these scenario planning conversations with your staff without describing dilution events - they're fairly inevitable. If you've told all the staff that there are three general scenarios, you're going to lose a lot of trust & goodwill when you hold the all-hands meeting where you announce "oh yeah, there's mystery scenario four, where your returns decrease in value, and there's nothing you can do about it, and we might do it again".
Many times when startups get acquired/whatever - founders will get next to nothing because the investors had liquidation preferences. The founders still go through with it though cause it allows you to start another company and raise rounds. If you become known as a founder who prioritizes himself over his investors - who is going to give you money…?
You can use milliShares, microShares, nanoShares, etc, to avoid expressing a $10,000 0.000000134 Share position. There should only ever be one share: The Company.
ADDENDUM: bonus if we get to a computational level that allows for arbitrary but valid rational numbers (with a data size cost to keep infinitesimals down) and replace fixed sized decimals, and modeling capabilities which allows us to list options contracts in a unified market, with arbitrary numeraires (think contracts for A priced in B instead of $) and expirations, and with any combination of strikes (compound positions), as one trade. BSM is continuous in all dimensions, and all it's really doing is expressing probabilities as price (plus a small uncertainty spread for risks and to goose out an edge out of Expected Value). This many expirations bins, many strikes bins, stuck to 100-share contracts, many (separate) stock vs USD bins, thing seems a bit too arbitrary when we have Wolfram Mathematica-tier abilities to handle the modeling for this stuff now.
It's not 1989 anymore, get Tom Sosnoff on the phone I'm sure he'd pitch this innovative idea! Maybe I'll call it into his show soon...
I was a tier 1 significant common shareholder in my own company and saw a bunch of shenanigans. The rank and file employee with 0.00X% stock options subject to weird rules and tax doesn’t stand a chance.
From the employees perspective, have to find a massive outlier in terms of company success and then hope to not get screwed or be diluted to hell. Lottery ticket odds are the right ballpark.
One thing you should do is support early exercise (meaning exercise any time, even before you’ve vested; company can repurchase and the same price any unvested shares if you leave). This is especially good for early hires when the price is extremely low and 83(b) means you avoid a tax bill until you sell. In later stage companies this doesn’t help as much though.
I do agree with the author that comp secrecy is not just stupid but destructive.
Is he suggesting that the initial job contract does _not_ state the exercise price, and relies on the employee mistakenly thinking that $0.01 is the exercise price?
This seems like it stems for a culture that we have of employees (or potential employees) just never asking questions about contracts that are presented to them. And I think there's a lot of employers that expect that to be the case too. I've once had a manager tell me with a straight face when I requested changes to a contract "I'm sorry, I can't get this changed. You'll just have to sign it." My reply of "I don't believe it's in my interests to sign that" was not something that was in his world-view.
I've only ever had options "work out" a single time and that was because long after I left the company (I bought my vested options), it went public and my options converted into actual stock. However, the stock was absolute shit worthless for about 10 years, so I hung onto it thinking one day, I'd sell it and harvest the tax loss. Then, during covid, WSB came along and randomly pumped it and my limit order for the very tip of the market, was actually filled. Much to my amazement. Then, the stock went to the bottom again almost the next day. I think I "profited" about $5k total out of that deal across many years.
My last company, was supposed to go through a SPAC, likely so that the execs could dump on retail. I spent like $30k on my options and near the end of everything in the hopes of getting some of it back, the whole deal fell through and I got laid off for the first time in my career.
Maybe I just have bad luck in these things, but every time I picked a higher salary over more options... it worked out better in the long run, by a lot.
Now that I'm CEO of my own business, I have zero plans to ever go public or even sell the company. I'd much rather have it be focused on stable revenue generation, and make sure to pay people well, and give company performance bonuses along the way. Yes, of course, we will also give options out, as the industry expects it, but I'm not going to make it a focus (by preferring good salaries, benefits and a stable gig). I'll be upfront about my plans for anyone joining. I would much rather be real with people than give them any sort of false hope. We are just starting, so let's see how that works out over time.
Idk if I’ll join a startup again in the next few years. It’s basically taking salary only - which can be anywhere from 1/2-1/4 of my normal pay. Why waste your time?
I hope one day startups will offer something of value again. For now, it’s a race to the bottom.
In my midwestern experience startups are paying more cash than other businesses where software is a cost center.
I'm not well versed in options lingo, is there something to describe this scenario?
You join with a very low strike price, such as $0.05 and get a lot of shares, let's say 200k to keep the math easy. At that strike price the value on paper is $10,000.
Then a liquidity event occurs before your options vest and now instead of 200k shares @ $0.05 you have 3,333 shares at $3.00 because the valuation of the company changed. You still have $10,000 in options.
The issue now is you've taken a huge loss in the multiplier effect. Having a stock go from $0.05 to $1 is a 20x jump. Hitting that would yield $200,000 in value.
But the odds of $3 turning into $60 is so much lower, but that's what you would need the stock to hit to yield the same return in the end.
In the end, over time you tend to get less stocks at a higher adjusted strike price with no real-world opportunity to exercise. Sometimes even if you have vested options you can only exercise a single digit percentage of your total shares so the total cash-out value is the equivalent of 1 day's worth of pay even after years of vested options.
A liquidity event wouldn't change your number of options in general. If you had 200k options before the liquidity event and you didn't sell any when the event happened, you still have 200k options after and their strike price doesn't change. The value of these options has changed because the value of the underlying stock has changed. It's absolutely not the case that your options get adjusted to keep the dollar value the same post-liquidity event unless there is a consolidation as described below.
Your terminology is a bit imprecise so it's hard to be 100% sure what you mean but I think you're talking about dilution. It doesn't work quite the way you wrote it down but the net effect is similar to how you describe as long as you think in percentage terms rather than number of shares at a price terms. Say your 200k shares represents 1% of the company (so there are 20m shares) and an investor comes in and puts in 20m for 50% of the company. This values the company at 40m (post money) but dilutes you so now your 200k shares is only 1/2% of the company. In theory whether this is good or bad depends entirely on the true value of the company relative to the price the investor came in for. If the company is worth exactly 40m with the new money then it's easy to say that it must be worth 20m before the money (because it's just the same company but has been given $20m), and 1/2% of a company worth $40m is exactly the same as 1% of a company worth %20. In practise your position is generally worse afterwards because the investor will usually get a "liquidity preference" which means they will get all their money out before you get a dime. So you have a smaller percentage and your position on the cap table is a bit worse than it was before. The hope is that the money and whatever else the investor brings to the table makes the whole thing better in a way that compensates for that.
There is one other scenario which can play out a bit like what you mentioned, which is a "reverse split" (also sometimes called a consolidation). This is somewhat rare and usually is only going to happen when the company isn't doing that great. So a split is where say the company has 100mil shares at $10 per share they split each of those into 10 new shares at $1 per share so if you had 200k options at 0.05, you now have 2m options at 0.005. Well a reverse split is the opposite of that so your 200k options at 0.05 become 20k options at 0.5 in the case of a "1 for 10" consolidation.
Your stuff about the multiplier effect is not really how stock trading works. Market professionals think in terms of percentages in general, so having a stock go from $3 to $60 is exactly the same as having it go from $0.05 to $1.[1]
When you say about only being able to exercise a certain percentage of vested stock - those restrictions are real but generally affect things more pre-IPO (and for a short lock-in period post-IPO) but in general exercise pre-IPO is very limited. But yes those sorts of restrictions are important and it's important to read your options agreement carefully to make sure you understand them.
[1]One exception to this is "Pink Sheet" stocks which happen to be both very low-priced per share and very volatile. The reason they are so volatile is that because of their low price they can't get a normal stock listing and so are extremely illiquid and subject to fraud and market manipulation etc in ways that are more extreme than normal stocks. Stocks with extremely low prices like this could do a reverse split to get their price into a normal range but choose not to, which leads most people to think they prefer to avoid normal market scrutiny. The other exception are stocks like Berkshire Hathaway which are illiquid because they are so high-priced (per share). They could fix this problem by executing stock splits but Warren Buffett has had a sort of religious objection to doing this. It's irrational and it hurts liquidity in this stock.
It did change. A new higher strike price was set and the share count was reduced so the $ value was the same in the end.
> Your stuff about the multiplier effect is not really how stock trading works. Market professionals think in terms of percentages in general, so having a stock go from $3 to $60 is exactly the same as having it go from $0.05 to $1.
Sure, the percentage is the same but isn't it "easier" for a stock to go from $1 to $3 vs $100 to $300? The 2nd one means the stock's value needs to jump by $200 but the first one is only $2.
It seemed like a mechanism to control the multiplier effect from producing a very high return.
Is there a specific name or way to categorize this type of consolidation for the example I provided?
i think best thing to do is not offer illiquid stock options but a sliding scale revenue share.
Of all the startups that I have been a part of, only 1 found buyers for the stock options but even then it was too little because it didn't IPO, it just sold to another player.
It's down right misleading to offer pieces of paper with the right to buy a stock that has almost nil chance of seeing retailers without disclosing the odds. The odds are close to nil for startups looking to IPO.
By doing revenue share, it forces you to be long term orientated, you are now focused on growing a steady stream of net positive cash flow. This puts you in a much better negotiating position, you can use leverage from banks to get anywhere from 30~60 cents on the dollar, to redistribute back into operations or bonuses.
THEN you can accept that invite from a VC or PE (dont recommend it due to the time constrained nature of PEs that are incompatible with long term orientated management) and absolutely have the odds in your favour.
Then the whole point of working for a startup is that you can have larger upside than in a more established firm, often 4x.
Finally even in established firms it is common for high compensation to be paid out in shares/stock options (be it in the company itself or a fund) and/or deferred, which is not any different anyway, except the value is a bit more battle-tested.
Personally, I've been around the block a bunch of times and have had more than my share of options as part of compensation.
My experience with them informs my attitude towards them: I don't count them as compensation when I'm looking at an offer from a potential employer. If the offer isn't good without the options, including the options doesn't make it better.
If you need a solid guide, I usually point at the Holloway Guide To Equity Compensation but I'm annoyed that it looks like they started charging for it (probably still worth both the time and money). The preview is worth checking out. That being said, I think there are a bunch of other aspects that aren't captured.
I was under the impression that founders/management generally don't give any company specific guidance in order to not be on the hook for anything that may be construed as guidance or promises.
Borders on misinformation to tell people that owning x% in shares equals x% of liquidity event. Even many founders end up with very little to show from an acquisition.
This is not Silicon Valley, but a fintech. Given I have not only my time but 10s of k of my money tied up in options due to strike price going up with each grant, in what way am I risking getting screwed?
In the comments here, it seems like I have a 60+ percentage chance of getting screwed through a dilution or other. However it doesn't feel that way.
What should I be on the lookout for? The Paperwork is dozens of pages long and I'm not an attorney.
Once you've stared that beast in the face, yeah, dilution is a thing that could happen, but it's not in anyone's interest to screw you over. If you get screwed over by your board, people are going to know, and not want to work with those people ever again. So dilution absolutely happens, but you just have you hope you're not gonna get screwed over. There's no legal guarantee that you won't though, so that's why the common advice is that that options are worth $0, until they aren't. So you have to look at options as a lottery ticket and ask how much you like the work and how much you like your coworkers, how much you like what the company does, and can you live off the pay you do get.
I would just refer to an attorney regarding anything would modify your shares or the agreement you already signed, because those things can't be arbitrarily modified without your consent.
Also, the most common way employees get "screwed" is when the company underperforms and has to raise money on bad terms, but there isn't much you can do about that.
Unfortunately, there is a fundamental problem with sharing market cap and number of outstanding shares with all employees (and prospective ones). This data would quickly leak to the competition and other unwanted hands.