In the November 13, 2018 Ask The Headhunter Newsletter a reader asks whether to accept stock options as part of a compensation package.

Question

stock optionsI’ve been with the same company for five years, with total 18 years’ experience. I’m considering an attractive offer from a year-old start-up financed by a very respected venture capital group. The offer includes stock options. The idea is that someday they’ll go public and will be hugely successful, or someone will buy the company, and we’ll all become rich (on paper).

My question is, how would I go about putting a value on the stock options offered? Understanding the risk I assume, what should I negotiate for? Any suggestions?

Nick’s Reply

Venture funding for start-ups by respected venture groups is slowly picking up after a lull of several years – and that’s a good sign for the economy. But don’t count any stock options before they hatch.

There are as many subtle variations on evaluating options as there are start-ups. You could do well, or you could wind up very disappointed.

I’ll offer you two simple rules of thumb. There is no finesse in this. It doesn’t even involve calculations; just a blunt point of view that I’ve developed as a headhunter during many years of dealing with people who’ve faced this situation. A very few have profited from options, but most haven’t.

Stock Options: Rule 1

The first rule is that the factors which influence a start-up company’s success or failure are unknown to you at this point, and you have virtually no control over them. More important, to varying degrees we can say the same about the founders of the company and those who are funding it.

  • Thus, any attempt you make to rationally analyze how much start-up stock to hold out for — or to estimate what that stock is really worth today or in the unknown future is a crapshoot.

Stock Options: Rule 2

Here’s my second rule:

  • All stock options in start-ups are worthless by definition because you cannot put a value on something you cannot sell.

How to think about that job offer

Now for my advice, based on those two rules:

  • Accept the offer only if the work and the compensation package without the options would make you take the job.

How to negotiate the job offer

Negotiate for all the stock options you can get. But beware: A company is not likely to give you more options than it has already decided on. Management has thought about this more than you have, under the guidance of people who put up their cash to start the business. Unless you would be a key employee whose expertise would have a key impact on the company’s chances of success, you probably don’t have much leverage to negotiate options.

Now here’s the most important thing to take away from this discussion:

  • Negotiate harder for salary, bonus, incentives, commissions and allowances, and consider the stock options a lottery ticket.

This is what will keep you truly motivated day in and out. While I understand when a start-up’s founders say they want employees who are truly motivated to “throw in with us and take a risk,” you must decide how much of a risk you can afford to take — and whether you’re willing to give up part of your own market value today (cash compensation) for a chance to hit it big later.

Talk with a lawyer

No matter what they put in your job offer, a startup is a special situation because the risks are different from those in a mature company (even a small one). That’s why you should talk with a lawyer to get your job offer reviewed before you accept it.

These Ask The Headhunter PDF books will help you with the compensation end of a job offer:

Fearless Job Hunting, Book 6: The Interview – Be The Profitable Hire. This works even when discussing salary with your current employer.

Fearless Job Hunting, Book 7: Win The Salary Games (long before you negotiate an offer), especially “The Pool-Man Strategy: How to ask for more money,” pp. 13-15. Sometimes it helps to ask casually.

Fearless Job Hunting, Book 8: Play Hardball With Employers, especially “Due Diligence: Don’t take a job without it,” pp. 23-25. This is a must when considering a job at a start-up, though this section applies to established companies, too.

Fearless Job Hunting, Book 9: Be The Master of Job Offers, especially “Non-Compete: Did I really agree to that?”, pp. 5-7.

This article by my own attorney will highlight some of the issues you should consider: Employment Contracts: Everyone needs promise protection.

What’s your tolerance for risk?

Here is a sobering question to test your tolerance to risk in this situation:

  • If you had a chance to buy into this start-up without working there, would you buy its stock today?

If you wouldn’t invest in this start-up as a bystander, why would you take part of your pay in stock?

No matter how many options you get, if the company strikes it rich, I guarantee you’ll look back and think, “I knew I didn’t get enough options when I took this job!”

If the stock winds up worthless, you’ll be glad you were doing work you really wanted to do, and getting paid a nice package in the meantime.

Have you ever taken stock options as part of a job offer (with a start-up or otherwise)? How did it turn out? How did you negotiate the details? How would you advise this reader?

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25 Comments
  1. Nick – 100% spot on with your answer.
    I took a position with a 12 year old company whose founder sold to a PE firm. New management came in, it was restructured and I was the last one of the of the new team to be hired. Great package with a promise of a big reward in 5 years when they expected to sell it. But the CEO’s vision was wrong and his execution just tanked the financial plan in less than 2 years. He was replaced, I left, and the new CEO came in with a great plan, which he executed well turning it around. But just before his payout, the PE firm sold the division and cut him out. So even with all the legal advice and contract negotiations the PE firm pulled the rug. The reason, California is an At-Will state. Last I heard they are being sued.

    But I also went through a process and lawsuit with another company only to find out that I spent tens of thousands on lawyers only to win, but not collect.

    • @Joseph: I forgot to mention what you pointed out. Turnover in start-ups is high! (So is greed, unfortunately.) That’s not to say taking a chance isn’t worthwhile, because it can be. My point is to assess the risks and rewards realistically. Don’t let anyone sell you a fantasy.

  2. “The first rule is that the factors which influence a start-up company’s success or failure are unknown to you at this point, and you have virtually no control over them. ”

    First rule: make sure you know your position and possible contribution and influence to the company.

    Five years ago, I started in a small oil company, partly to escape from the previous employer, partly due to the geographical focus of the company I went to. I knew their strategy was somewhat…fragmented, but hoped to help steer them in the right direction. The company was public, so I had the possibility to buy shares.

    It soon became clear that management was both incompetent and deaf to input. Two years forward, I jumped the sinking ship, which escaped bankruptcy only by firing nearly all employees and selling all assets. I never bought any shares.

    On the other hand, my current employer has been through a turnaround, which now gives results. May be time to buy some shares in the holding company that owns us.

    We also have options in our company, but they are can be exercised only if the company is acquired or independently listed. I regard them solely as a free lottery ticket.

    • @Karsten: I’m a big believer in being an owner of the companies we work in. Otherwise, why work there? (I hold a huge stake in my own business – haha.)

  3. We can expand Nick’s excellent advice to established firms too. I was offered stock options as part of a bonus package. There was a caveat that should the firm be acquired, the asking price had to be at least $x, or the options would be worthless. The company was acquired, for less than $x, and the options were discarded. It did not bother me because I never figured the options into my pay nor my attitude towards my work.

  4. Nick’s comment about the options being a lottery ticket are spot on. Depending on who’s doing the analysis, something like 75-90% of venture backed firms will go out of business/fail/not achieve expected returns. Venture firms invest with the understanding that only a small percentage of companies are going to hit it big so they can exit with a profit.

    Likewise, one should consider options to be worth less than the paper they’re written on.*

    * Obviously, this is different if you’re a founder. But if you’re working for wages, you don’t get to pay your mortgage and utility bills based on how much you make by exercising options. Cash talks, BS walks.

  5. Joining the chorus: You nailed it

    Options for a start up (and to a lesser extent, even an existing public company) are the “bright, shiny object” used to distract job seekers.

    And I worked at a company which, after I left, arbitrarily and capriciously cancelled all stock options except for the handful of C-level execs at corporate. I made a reasonable amount of money on MY options there (as a division CFO) but the poor slubs who still worked there got zip. The lesson: options sometimes can be canceled – be very, very careful. It’s not really money in any situation until you exercise your option and sell the stock and have real cash on hand.

    • @Albert: I should have shared a personal story. At one point in my career, a client asked me to run his fledgling new tech company as its president. I put my business on hold and took the gig. The pay was crappy, but the work was fun and exciting — and as part of the deal I got 250,000 shares of the original 1,000,000. My contribution was to bring my own clients on as customers of this electronics custom design firm. Such a deal, eh?

      Boy, was I naive in more ways than one. After 6 months I realized the founder was (1) stealing from the biz (e.g., he doctored receipts for $100 to say $1,000 then collected expense reimbursements until I audited some of our vendor accounts), and (2) the profits were going up his nose. After I quit, he immediately diluted the shares by a factor of 10. Then he and his brother dissolved the C corp and folded it into a new one.

      I got zilch for my shares after stupidly agreeing to a low salary “so that we could plow our earnings back into the biz.”

      How do you think I got the idea for this advice? :-)

      Live and learn. Rack ’em up and play again, more wisely.

  6. Spot on. This applies to startups and those several years past startup. In my case, I was given an option package after working at a firm three years. The caveat was that the options would fully vest after five years, sooner if the firm was acquired. I accepted the golden handcuffs. Three years later there was an internal shakeup and several original pioneers were let go. A year later a foreign firm acquired the company. Now the fun part! As best as I can remember, because the strike price differed from the option price, those with options had to pay the difference or lose their options. Many were unable to buy them so lost them. Thankfully my mother in law understood the dynamics and loaned me the money so I could buy my options and cash out. Of course, that was never mentioned as a possibility five years earlier. One can never predict the future. Accept them. But don’t gamble with them.

    • David: Very good point about options, because that’s how options work. You have the option to buy stock at a previously agreed-upon price (the strike price). You will only exercise that option when that strike price is lower than the current actual price.

      Part of the “get rich quick” myth is dependent, in part, on an acquisition event that concurrently buys that stock from you so you can cash out. If the acquiring firm doesn’t agree to buy your stock, you will have to exercise the options (pay for the underlying shares at the strike price) to retain the ability to some day sell those shares at a higher price. When you own a minority of a privately held company, you do not have control over when and how you can sell those shares.

      • Yes, I wanted to come here to say similar things to Annette and David. I ended up working for a startup that wasn’t super new, but still was fully private and had no immediate plans to either sell or go public. I got stock options in my offer, but they’re just an option; in order to actually buy the stock, I would have needed to invest about $4k, and that’s a lot of money for me. In the end, I quit the job to start my own business, and decided that $4k was much more valuable to me as runway than as stock sitting around somewhere. So, in the end, it was part of my “compensation” but I was never in a position to actually get it. Ah, well!

    • @David: You’ve brought up another important factor: Opportunity cost. I can’t count the number of EEs I met in Silicon Valley who treated their options as golden handcuffs. They’d turn down other good opportunities because they couldn’t see their way clear to “give up the options” even when the options clearly had little chance of paying off. It’s an emotional bind and start-up founders (and their VCs) use it to keep employees from leaving.

  7. Hi Nick,

    Your advice regarding startups is solid. I’ve been involved in seven new (ad)ventures over the last 40 years. Two crashed and burned, two were acquired by very large companies, one morphed into new companies, one joined the living dead, and one became a sustainable family business passed from one generation to the next. It takes at least 7 years to get a company off the ground.

    When I interview people I always advise them not to join if they think they’ll get rich. The odds are massively against that happening. They should join if they can truly add value, are good at diverse fast-paced problem solving, have a mature emotional perspective, physical and mental endurance, and love working with a group of crazily resourceful high-energy creative types. Some people continue to join new ventures because (like me) they love it, they’re addicted to the action and the learning, and the last venture didn’t work out the way they expected.

    Some risks within new ventures: Inexperienced founders, sudden market shifts, cash flow disruption, loss of critical personnel, and investor decisions. You have no control over any of those risk factors.

    Some risks to individuals: Exhaustion (mental, physical, emotional), marital and family problems (you’re working all the time), addiction to the lifestyle (one becomes an adrenaline junkie), wasted years out of one’s life, or one gets lucky and cashes in the options. Yes, that last item can be a problem. I was advised years ago by a serially successful entrepreneur that most of the lucky ones end up wasting their first windfall by elation and bad decision making. He was right. I got lucky once and ended up completely gutting and rebuilding the basement of my house and adding a big sunroom. Years later I wondered why the hell I did that – having got hit with increases in property taxes and heating and electric bills and intermittent periods of significant unemployment.

    My advice to folks thinking of going into startups is to treat the options as fake money. If you get hired, get really good at what you were hired for (continuously experiment and learn and refine), concentrate on building a good network of advisors and problem solvers, hone your own problem-solving skills, plow as much salary as you can into retirement plans (and education plans for offspring), and build an emergency cash reserve (over time) equal to one year’s salary. You’re going to need it.

    Startups are fundamentally a long-term stamina contest. The last venture standing wins, but that does not necessarily mean you will. Again, it takes 7-10 years to know if a venture is really going in the right direction and a lot of personnel fall by the wayside. Don’t ever go into it because you think you’re going to get rich. Do it to learn a diverse set of skills and perspectives, develop self-confidence, get to know amazing people, and have fun.

    BTW: Nick, I’ve been reading your blog for years and have strongly recommended it to my son who enters the workforce next year from graduate school. Keep up the great work. You’re a terrific resource and a breath of fresh air!

    • @Wayne: Thanks for your very kind words, and best wishes to your son! And thanks for your insights and advice, especially this, which I believe encapsulates some of the best reasons to join a start-up:

      My advice to folks thinking of going into startups is to treat the options as fake money. If you get hired, get really good at what you were hired for (continuously experiment and learn and refine), concentrate on building a good network of advisors and problem solvers, hone your own problem-solving skills

      The learning experience and the chance to develop great new skills and relationships can be the truly big pay-off!

  8. Zero times anything is still zero. I worked at 4 startups in my life and walked away from 4 stock options. If your grifting skills are up to par, try negotiating a trade of the options for another perk. Maybe a company car or something useful and valuable to you

  9. Totally agree. The decision should be made not considering the options at all.
    I did make money on options I got upon joining an established company because the flubs of a competitor drove up its price for the first year. But the place was such a mess that I walked away after that year and gave up my other two years of options.

    Word of warning, gained from the tribulations of many during the 2001 bubble. If you exercise options, sell the stock immediately, if possible. Many back then exercised their options, which made them liable for tax on the difference between the strike price and the price when exercised. Being optimistic they held the stock, and when it plummeted didn’t have the money to pay the taxes.

  10. Excellent advice from Nick, along with this follow up discussion on how to best approach a start-up roller coaster ride. My perspective comes from a twelve-year experience with a biotech start-up that eventually failed leaving employees with only a two-week notice. Know your own risk tolerance. Stock options are best considered as a ‘bonus’ you don’t need. A bonus, that you pay for if you elect to exercise.
    The goals of a start-up are to develop concepts, process and product as well as marketing those concepts to investors in order to keep the think tank running. Sadly, if the marketing stategy over states actual progress, the achievement of milestones can be fatally compromised. Don’t fall into the trap of the lure of options as a replacement for compensation in your hiring offer OR as an alternative to a salary increase. Good luck out there!

  11. I was offered stock options to stay when I resigned from a job once. I left anyway. Two years later the company laid off half the employees. I would have been laid off. My stock options would have been worthless.

  12. There is a book which describes stock options and the tax consequences very well. Do not exercise your options until you know if you’ll pay AMT. When you do excise them know the valuation as well as the strike price.
    https://www.amazon.com/Stock-Options-Dummies-Alan-Simon/dp/076455364X/ref=sr_1_3?s=books&ie=UTF8&qid=1542164253&sr=1-3&keywords=stock+options+for+dummies

    Now, we invested in one company and that worked out well. We exercised our options in another company and 5 years later they wrote me a note saying the company sold itself and my options were worthless. Options are worth nothing. Once you exercise your options then the stocks may be worth something. but it if it a private company you can’t tell what that is. But mostly, if it is a private company it is probably worth nothing still.

    • There’s another good book, Sizing Up a Start-Up by Daniel S. Rippy — unfortunately it’s out of print. But it seems you can buy a copy on Amazon for either $136 or $1.95!

  13. Always think of stock options as a bonus rather than part of your salary. Many companies will put a lot of pressure on you to accept them in lieu of a portion of salary, but I strongly recommend against doing so.

    Stock options have to be exercised when you leave a company for any reason (lay off, fired, or resigned). That means you may have a binary choice of exercise them or walk away from them if you cannot or have not chosen to exercise them while still employed (see below for more on this).

    For private companies, the grant price is somewhat arbitrary but usually is quite a bit lower than the expected IPO price if the company ever goes public (the stock options are completely worthless if it doesn’t). If – and this is a big if – the company goes public you can do very well. However, most private companies either remain private or go out of business without ever going public.

    Stock options usually have to vest and that means if you get laid off (which is more likely for a start up than a more mature company as they often do not have a good handle on how fast to grow or the best order to hire for different roles) your options may go away (if they are not yet vested). Alternately, you may be required to exercise the options before they are worth anything (while the company is still private) and thus have to choose between taking a big gamble or letting the options go.

    For public companies stock options offer less potential upside but are less risky too. Often the grant price is the public price of the company at the time of the grant so you’re not getting a deep discount as you would with the private company. If the stock price goes up before you exercise the grant you can make an immediate profit and if it doesn’t then you can just let the options go with no harm. Assuming they’ve vested, the options always have some value so if you get laid off you know whether it’s worth exercising the options or not (although you can still exercise and hold if you think the stock will continue to rise in the future). You are more likely to get some money from stock options for a public company, but it’s not likely to be a lot of money. There are tax implications from exercising public stock options so you may want to consult an accountant or tax attorney first.

    • Janice – you are correct in this and I figured I’d also explain the strike price, which you also described as a grant price. If the strike price is less than the price of the underlying stock at the time of grant, the company has to treat the difference as current income to whomever is receiving the options. None of us want to pay taxes on something that might not have value in the future.

      Of course, valuing a privately held company is a tricky thing; there’s a lot of leeway in that. For completely different reasons, the company generally has an incentive to show higher valuations, which can then adversely impact the value of newly granted options. (We’d all prefer the value of an option to be as close to zero as possible.)

      If you are at a company and they are getting a 409(a) valuation done, it’s often because they want to grant options and have to prove some sort of valuation that was completed within a year of when those options are granted.

      (Of course, some small companies just do what they want and hope they don’t get caught. Then all these rules go out the window!)

    • @Janice & Annette: Thanks for the details about strike/grant price. This is why I suggest doing an exercise before you take an offer where options seem to be the attraction. Ask yourself, if you weren’t considering this job but were offered a chance to buy the company’s closely-held stock (that is, there is no public market for it), would you make the investment? If you would, then take the job because that’s what you’re doing — investing in the company rather than being directly paid for your work.

  14. If they offer you stock options and you aren’t a founder, ask to use the rest room. You will find an equivalent value of paper in the stall, in a easy to use dispenser. Most people get screwed by a dirty little secret called ‘preferred stock’ which you can google to learn about.

    Sorry if this was a bit too harsh for a Jersey guy.

    “Accept the offer only if the work and the compensation package without the options would make you take the job.”

    Bingo.

  15. Why would anyone take a sucker deal for a “peeing on your shoes” stock option from a little fledgling start up company that you know little to nothing about?

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