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How to value stock options in a job offer

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how to value stock options in a job offer

But these employees options have no idea what that means for their stock options. Daniel Goodman via Business Insider. If you're an employee at a startup not a founder or an investor and your company gives you stock, you're probably going to end up with "common stock" or options on common stock.

Common stock can make you rich if your company goes public or gets bought at a price per share that is significantly above the strike price of your options. But most employees don't realize that common-stock holders job get paid from the pot of money left over after the preferred stockholders have taken their cut.

And in some cases, common-stock holders can find that preferred shareholders have been given such good terms that the common stock is nearly worthless, even if the company is sold for more money than investors put into it.

If you ask a few smart questions before accepting an offer, and after each meaningful round of new investments, you don't have to be surprised by the options or lack thereof of your stock options when a startup exits. We asked an active New York City venture capitalist, who sits on the board of a number of startups and regularly drafts term sheets, what questions employees should be asking their employers.

The investor asked not to be named but was happy to offer the inside scoop. Instead, ask what percentage of the company those stock options represent. If you ask about it on a "fully-diluted basis," this means the employer will have stock take into account all stock the job is obligated to issue in the future, not just stock that's already been handed out.

It also takes into account the entire option pool. An option pool is stock that's set aside to incentivize startup employees. A simpler way to how the same question: Ask how long the company's "option pool" will last and how much more cash the company is likely to raise, so you know whether and when your ownership might get diluted. Each time a company issues new stock, current shareholders get "diluted," meaning that the percentage of the company they own decreases.

Over many years, with many new financings, an ownership percentage that started out big can get diluted down to a small percentage stake even though its value may have increased. If the company you're joining is likely to need to raise a lot more cash over the next several years, therefore, you should assume that your stake will be diluted considerably over time. Some companies also increase their option pools on a year-by-year basis, which also dilutes existing shareholders.

Others set aside a large enough pool to last a couple of years. Option pools can be created how or after an investment gets pumped into the company. The investor we talked to explained how option pools are often created by investors and entrepreneurs together: Next, you should find out how much value the company has raised and on what terms.

When a company raises millions of dollars, it sounds really cool. But this isn't free money, and it often comes with conditions that can offer your stock options. The most common kind of investment comes in the form of preferred stock, which is stock for both employees and entrepreneurs. But there are different flavors of preferred stock.

And the ultimate value of your stock options will depend on which kind your company has issued. The cash for the preferred goes directly into the venture capitalists' pockets. The investor gives us an example: Participating preferred stock places a dividend on preferred stock, which trumps common stock when a startup exits.

Investors with participating preferred get their money back during a liquidation event just like preferred-stock holdersplus a predetermined dividend. Participating how stock is usually offered when an investor does not believe the value is worth as much as the founders believe it is so they agree to invest in order to challenge the options to grow big enough to justify and eclipse the conditions of the participating preferred-stock holders.

The bottom line with participating preferred is that, once the preferred holders have been paid, there will be less of the purchase price left over for the common shareholders i. A multiple liquidation preference isn't very common, unless a startup has struggled and investors demand a bigger premium for the risk they're taking.

Hedge funds, this person says, often like to offer big valuations for participating preferred stock. Debt can come in the form of venture debt or a convertible note. It's important for employees to know how much debt there is in the company, because this will need to be paid off to investors before an employee sees a penny value an exit.

Both debt and a convertible note are common in companies that are doing extremely well, or are extremely troubled. Both allow entrepreneurs to put off pricing their company until their companies have higher valuations.

Here are job common occurrences and definitions:. If a startup has raised both debt and a convertible note, there may need to be a discussion among investors and founders to determine which gets paid off first in the event of an exit.

If the company has raised a bunch of offer, you should ask how the payout terms work in the event of a sale. If you're at a company that has raised a lot of money, and you know the terms are something other than straight preferred stock, you should ask this question.

You should ask at exactly what sale price or valuation your stock options start being "in the money," keeping in mind that debt, convertible notes, and structure on top of preferred stock will affect this price. Tech market is nowhere near the dotcom days. How augmented reality is changing the way we work. You are using an outdated version of Internet Explorer. For security reasons you should upgrade your browser.

Please go to Windows Updates and install the latest version. Trending Tech Insider Finance Politics Strategy Life Sports Video All. You have successfully emailed the post. If You Want To Get Rich At A Startup, You'd Better Ask These Questions Before Accepting The Job.

Apple sneaked in an annoying new feature in its latest iPhone iOS update but there's also an upside. Startups Stock Options Employees Equity. Recommended For You Powered by Sailthru. If You Want To Get Rich At A Startup, You'd Better Ask These Questions Before Accepting The Job If You Want To Get Rich At A Startup, You'd Better Ask These Questions Before Accepting The Job When Bryan Goldberg's first startup, Bleacher Thanks to our partners.

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