Any advice for if the company has not received outside investment and has no plans to seek it?
The best I've been able to come up with is to make a guess as to how much I think the company might one day be worth and then estimate my stock's value based as a percentage of the issued stock. I know my stock can be diluted, but I'm not really sure how to take that into account at this point.
You should also include unallocated options in the calculation of your percentage. For example, how many options does the company plan to issue in the next 12-18 months?
This is like including unallocated options in a fully diluted basis.
If I understand correctly, here's what this means:
- Last round, the investors bought in at, say, $10/share. They got preferred stock, which gives them access to more of the company's assets in the case of failure and certain other rights (like maybe they have a say as to whether a certain acquisition can go through), but otherwise represent the same portion of equity as shares held by any other stockholder.
- If you're getting incentive stock options, you'll be getting common stock. This is worth much less than preferred stock, say $1 instead of $10, because in the worst-case it is worth nothing whereas the preferred stock might be worth a gently used Aeron or two.
- If the company is doing well and on track to an acquisition, the acquirer will buy all the stock. They'll pay at least $10/share, since that's what it'll take to prevent the last round of investors from losing money.
In the acquisition, does the acquirer pay the same price for a share of stock, whether preferred or common? If yes, then I think this all makes sense; if no, I've clearly missed something important.
What if the preferred stock has a liquidation preference and the amount is smaller than their investment? There are some cases where the preferred shareholders can get paid and not the common right?
Obviously you weren't talking about that sort of acquisition, but it does highlight the point that common stock would be worth somewhat less than preferred due to that potential unless I misunderstand something.
I believe that "lottery ticket" thinking is really dangerous.
It leads to making really awful financial decisions. At many companies, people don't do enough math to realize how little their options are worth. And so slog it out for years thinking it is a good deal.
And many companies will argue that paying below market is justified because they're giving you options. If you do the math, you might find out that the lottery ticket, spread out over 4 years, diluted by liquidity preferences and successive rounds don't come close to the aggregate bonuses from a 'regular' job.
True story:
At my last startup, as I was leaving, I created a spreadsheet that took everything into account (liq. pref., multiple rounds, etc.) so you could plug in the options you had and an acquisition price and see what you'd make.
I went and showed it to some folks to make sure I'd done all of the crazy math right. It turns out that
I'd like to hear more about exercising options early. I had no idea that could be done. Not that I'll ever be in that situation, but I'm just curious how that happens. Sounds like a bit of a legal hack. Did you mean with the 83b form?
I did exactly this when I joined justin.tv - it's not very difficult to arrange. The hardest part was actually finding a CPA who had any availability to work with me, and who I felt I could trust (he came recommended by a friend).
It's obviously important to keep in mind that to exercise your options you'll need some cash. If your share is big and the company has been well funded already, you might need a lot of cash. And you need to be prepared to lose it all if the company fails.
Your answer here is completely unclear to me. I understand you don't want to give out legal/money advice, but can you at least explain the capital gains thing you were talking about.
I am neither a lawyer nor an accountant, so I don't know what the tax/legal issues are with cashing out and/or capital gains, nor it's "clock". But I do have stock options that are vesting and I do have to decide if I want to exercise them early, or not. When this issue first came up, no one knew or seemed to think there was any difference between exercising the options and not exercising the options. I did it because everyone else did it. Probably a bad idea, huh?
Here's the deal: you want the gain in stock value to be taxed as "long term capital gains", which is a much lower tax rate (~15%) than as income tax (~30%).
To do this, you need to sell the stock that you purchased with the options at least 2 years after you received the options and at least one year after you exercised the option.
What many people do is purchase options to 'start the clock' on that one year window.
A much more complex way of doing this, which I've been on the receiving end of, is to grant your employees their options immediately upon them joining and have an agreement where the company can repurchase them (at no cost to the company). The amount that the company can repurchase is reduced each month.
The best I've been able to come up with is to make a guess as to how much I think the company might one day be worth and then estimate my stock's value based as a percentage of the issued stock. I know my stock can be diluted, but I'm not really sure how to take that into account at this point.