The question arose: how do you evaluate how much options are worth when considering a job offer at a startup? My answer: at the time of the offer, they're probably worth very little, but over time they may become worth enough to make leaving the company painful.
Here's my reasoning. When you get an offer from a startup, they'll offer you some shares at a certain price. That price is usually about the same as the price that was paid during the most recent round of funding. And the price that was paid during that round was exactly what the shares were worth at that time. For example, suppose the most recent round of funding infused $10 million, in exchange for 10 million shares. Then a share is worth about $1.
It would be foolish for a new employee to reason that the "real" value of a share is $10 simply because that's what it will trade for if the company manages to go public in the future. Instead, you should assume that the investors took into account the probability of the company being successful, and they paid exactly what they thought the shares were worth at the time -- only $1. After all, that's the investor's job.
If you join a company that hasn't had a new round of investment recently, then you can hope that the current value of the company is more than it used to be, and therefore the options you receive are worth more than the strike price you'll have to pay for them. In that case, they're actually worth money. But this disparity gets reset whenever the company receives another investment.
Now consider the effect of options on an employee that has been with the company through more than one round of investment. Suppose they received 10,000 options when they joined, and at that time the options were worth $1, and cost $1 to exercise -- for a net value of $0. But over time the company's value has grown, and the most recent round of investment valued the shares at $4. Now those 10,000 options have a net value of $30,000. Because the options vest over time (typically over four years), this $30,000 can be seen as an extra $7,500 salary per year.
The longer you stay at a company, the more successful the company generally becomes (this is survivorship bias: the unsuccessful ones go out of business). The interesting thing is that the value of options grows slightly faster than the rate of growth of the company -- and that is in sharp contrast to salary, which tends to grow at a much slower pace. So, the longer you've been at a company, the more impact your options will have on your salary. Eventually. the majority of your income might be due to options.
This is exactly why companies like options: they provide an incentive for the most senior employees to stay at the company.
Posted on February 5, 2004 04:48 PM
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Companies like options for another reason--they cost the company nothing to issue, nothing to hold, generally evaporate into nothing, and yet the employee lives with the fantasy that they're actually worth something. It's a wonderful tease and issuing them to the whole company costs less than even a single foosball table. Occasionally they do turn into something worthwhile, but even then the way they materialize still costs the company's current management and original investors nothing, as they're generally paid out from cash provided by new investors. It's a great win for the company.
I'd not take them in lieu of salary, and not count them as meaning anything from a company that hasn't gone public with a reasonably good track record. (And those companies tend not to offer them)
If you do take 'em instead of cash, well, make sure you get a good look at the company's books first (as you're essentially coming on as an investor, invesing sweat equity into the company) and ask for a kiss while you're at it.
Posted by: Dan at February 5, 2004 08:30 PMThis week I've been interviewing at a startup and expect to be offered more options and less salary than my previous job. My general take on options is that yeah, I could luck out and they could be worth a lot, but I should plan my finances for them to be worth $0.00, which planning includes salary negotiation.