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An Engineer’s guide to Stock Options

blog.alexmaccaw.com

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Re: An Engineer’s guide to Stock Options

#111

Post by 7Figures2Commas »

tptacek wrote: post #44
7Figures2Commas wrote: post #24

There's some valuable information here, but a lot of detail is lacking. For instance, the post does not distinguish between incentive stock options (ISOs) and non-qualified stock options. The tax treatment is quite different. More importantly, technical details aside, I think it's important for a prospective employee to make some strategic decisions about equity up front. The author writes: > If the company seems rel…

I think you make a valid point but may have picked the wrong hill to fight for here, because there is no way to evaluate an equity grant without knowing the percentage associated with the grant. Even if you don't care much about equity, if you care about it at all you should be able to get that information.

> ...because there is no way to evaluate an equity grant without knowing the percentage associated with the grant. Even if you don't care much about equity, if you care about it at all you should be able to get that information.

1. Calculating a true percentage associated with a grant can be difficult. You can identify the number of shares of stock outstanding across all classes, the number of currently authorized shares, and the size of the option pool. But you don't know how much of the option pool will actually be used, how many options will vest, etc.

2. Unless you're an executive hire or unicorn, most companies will not give you all of the data necessary to meaningfully evaluate the equity grant. You can ask for it, as so many suggest, but asking for something that a) you almost certainly won't receive and b) that you're not trying to focus on (for the reasons I originally gave) is not very strategic.

3. At an early-stage, venture-backed startup (my comments are not intended to address late-stage, liquidity-all-but-certain scenarios), the equity structure of the company is likely to change considerably and perhaps unpredictably, rendering your initial evaluation all but useless.

4. If an early-stage startup is capable of offering you a satisfactory salary (at market or, these days, above market), you are far better off trying to ascertain what the company's runway is. Your biggest risk at a startup is not that you're going to join the next Facebook as an early employee and walk away with next to nothing but rather that the company is going to run out of cash.

Re: An Engineer’s guide to Stock Options

#112

Post by yajoe »

JshWright wrote: post #30

I like thinking about shares as a virtual currency. Shareholders are speculating on that currency, and the company is trying to increase its value. Companies can inflate or deflate this currency depending on their performance, perceived potential or by issuing new shares. I consider myself a fairly smart person, who had a reasonable grasp on the basics of financial markets, currencies, etc. That simple paragraph just…

Yes, many public stocks on major exchanges are just other forms of currency. It just depends on whether the underlying asset is highly liquid (which implies easy to trade, confidence it will exist in short and long terms, etc). I would humbly submit not to get hung up on the word 'virtual' since the practice of using stocks as a liquidity source (and at times to actually print money) have been done a few times in the past.

My favorite example is from the 1890s: Amalgamated Copper

Summary: http://www.jstor.org/stable/1884999

Book describing the process of getting banks to print money by ficticously reporting assets: http://www.gutenberg.org/ebooks/26330

Had the author written the book today, he would compare the practice to quantitative easing or injecting liquidity: http://en.wikipedia.org/wiki/Quantitative_easing

The big difference? Amalgamated Copper was a private entity whose owners used fraud and banks to print them millions of dollars.

Re: An Engineer’s guide to Stock Options

#113

Post by tptacek »

7Figures2Commas wrote: post #111
tptacek wrote: post #44

Earlier quoted context omitted.

I think you make a valid point but may have picked the wrong hill to fight for here, because there is no way to evaluate an equity grant without knowing the percentage associated with the grant. Even if you don't care much about equity, if you care about it at all you should be able to get that information.

> ...because there is no way to evaluate an equity grant without knowing the percentage associated with the grant. Even if you don't care much about equity, if you care about it at all you should be able to get that information. 1. Calculating a true percentage associated with a grant can be difficult. You can identify the number of shares of stock outstanding across all classes, the number of currently authorized sh…

These all seem like really good points. I'm going to keep my part of this conversation very narrow and just re-assert that if you ask for the percentage corresponding to your grant, you should get it, without much trouble. Not getting it is a very bad sign. I'd say the same thing about current liquidation preferences.

You're absolutely right that nothing your employer tells you at the time you're hired is going to be controlling once a new round of funding is taken. If the company is going gangbusters when it takes a new round, the new round probably won't hurt you at all. If it's a slog when you go for more money, it could totally ruin your returns.

Re: An Engineer’s guide to Stock Options

#114

Post by nwatson »

pixelcort wrote: post #102
grellas wrote: post #43

Really nice write-up explaining stock options. A few added thoughts sparked by some of the comments already made in this thread and otherwise: 1. The value of options is inextricably linked to tax and you need to understand the tax basics in evaluating the economic risks and benefits of holding and exercising any kind of option. With NQOs, you are taxed on the spread as ordinary income on the date of exercise (meanin…

So it's always better to own the stock ASAP (with risk of forfeiture) and get the 83(b) set up? Are most startups willing to arrange this for early employees?

You risk losing a lot with early exercise. The expected return on a $1 investment in option exercise is ??? hard to say.

What's even worse though is three years into employment deciding you hate your job and that you want to leave, realizing that staying and being alive are incompatible. And here we get real hypothetical ... you think the company has legs and that your stock might be worth something. But your strike price is $.05 per share and fair market value on Common Shares now is $1.50 per share. If you exercise your three years of options at this point hoping for the likely $10 per share IPO, you're stuck paying immediate regular income tax rates on your $1.45 per share immediate paper gain. And you may not have enough money to pay those taxes because they far outweigh your outlay for the stock exercise itself. And then you also risk the company going bust and you may end up with deducting max $3k/year in capital losses for the rest of your life.

That scenario is why I like buying up front in an early exercise.

In my last company I did the early exercise, though. And I stuck around for a long time. And that early stock was highly diluted and ended up being a small fraction of my overall stock option grant. I'm not sure it was worth it but we finally were acquired.

Re: An Engineer’s guide to Stock Options

#115

Post by richardburton »

anon_nsotax wrote: post #94

Can someone comment on determining fair market value of a private company? I exercised NSO stock options of a private company after being vested for a year. Everything I read indicates I need to declare the spread of current FMV with the value of the option grant date. How do I determine the current FMV if their is no market though?

You'll need to ask the owners of the company for the 409A valuation.

Re: An Engineer’s guide to Stock Options

#116

Post by gabemart »

patio11 wrote: post #58
vikas5678 wrote: post #52

Is it odd that almost every startup I or my friends have interviewed with refuse to answer the "number of outstanding shares" question? Have others had similar experiences?

Without some notion of how much your equity grant represents of the company (by current dilution), the actual number of options you get cannot be sensibly valued. The total number of shares at a company is totally arbitrary . Seriously, when you register one, the state just asks you to pick a number . If a company won't tell you enough to calculate the percentage, that's like you asking "What's your offer for salary?…

Please forgive my ignorance, but if you know the number and price of the options, is the problem that you don't know the current valuation? Because it seems like if you know the price of the option, how many options you're being offered, and the current valuation, it's trivial to work out the number of outstanding shares. I guess the current valuation is privileged? Or that there is no current-valuation if it's been a while since the last round?

Re: An Engineer’s guide to Stock Options

#117

Post by SeoxyS »

arielweisberg wrote: post #6

I thought 83(b) only helps with RSU grants? For ISO grants I thought you can't do an 83(b) election? Can anyone clarify?

That is actually incorrect. Many here have replied that only 83(b) elections only pertain to RSUs. In fact, it also applies to early-exercised ISOs; when you buy the shares before they actually vest.

Source: I've done this. I've early exercised ISOs and filed an 83(b).

Re: An Engineer’s guide to Stock Options

#118

Post by gatehouse »

tptacek wrote: post #96
gatehouse wrote: post #79

Earlier quoted context omitted.

If you don't know who owns the company you don't even know who you work for. It might not matter to most people as long as the cheques don't bounce, but if you want to even hallucinate having a meaningful role in the direction of the company it starts to matter. I really don't know what people are willing to disclose to employees but the SEC rule for public companies is a 5% stake or more is disclosed.

This is not true. It matters who your company directors are. It does not matter how much of a stake some random angel investor ended up with, or how much the VP of Product Marketing got. I have founded a company where I didn't know what the cap table was (obviously, I could have) and I assure you I had all the influence I wanted on it's direction. The cap table is, to this whole conversation, a MacGuffin.

I agree that the directors are who really matters. It matters which groups of people can make 50% + 1 of votes, because they can select the directors.

Re: An Engineer’s guide to Stock Options

#119

Post by kika »

gesman wrote: post #109

Red flags (from personal experience): - "We will give you a big share of our (of-course-soon-to-be-facebook-or-google) company (15%+ in stock options) if you'll agree to work for us for close-to-nothing". - Senior officers starting leaving the company one by one. - Senior officers giving small promises that have tendency not to materialize. - Senior officers do not have any/good exit track record. Opposite would be a…

I'm not getting #1. Essentially, they're offering you a "founder grade" share of the company. Why not?

Re: An Engineer’s guide to Stock Options

#120

Post by joshuapayne »

balls187 wrote: post #108
elwell wrote: post #97

What if you're too lazy to exercise your share?

Usually the Employee Share agreement has a clause that states that when you leave the company (or even in change of control scenarios) any vested stock options must be exercised by 90 days, otherwise their forfeit back to the company.

This is important. The 90 day time period is a typical clause in your options agreement. It is not universal. You should check for this and other "standard" clauses in your options agreement to ensure that your company isn't sneaking something past you when you're signing on.
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