Employee’s Guide to Stock Option Compensation

We live in an age of startups where every other person with a half-decent idea is trying to become the new Mark Zuckerberg or Pierre Omidyar or Jeff Bezos. In many cases, startups do not have too much money to throw around, especially in their early days. Because of this, they have come to a solution where they offer stock options to new employees as a way of compensating them for the work they do.

As someone looking for a job, you might have already encountered this, but did not know how to respond or what questions to ask. Since stock options are quite a complex issue, there is plenty to factor in and the questions you will find below are a great start. Without getting the right answers to these questions, it is probably best to avoid such an employer.

Inquire about company’s future

Before anything else, you need to know that your potential employer has a clear and worked out plan to succeed. Any fool can have an idea and scrounge up some money to register as a C corporation. They need to convince you that the shares you will be granted will actually have value down the line. In order for this to happen, their startup needs to succeed. If they are being iffy with providing proof (analyses and projections), they are hiding something.

Inquire about the percentages

Do not get fooled by your employer simply stating the number of shares that you will be getting. The number means nothing. Only in relation to the overall number of shares does it make sense. Also, make sure to inquire about the percentage your stocks will be worth once the stocks are “fully-diluted”, meaning when everyone has had their share. It might also be a good idea to find out how long the “option pool” will be lasting and how much longer will the stocks keep being diluted.

Inquire about future options

Many companies continue to grant further stock options to employees who have proved their worth. Not all companies practice granting of additional options and it is always a good thing when your potential employer has a plan in place where they will provide additional options grants periodically. This is another indicator that they expect the company to perform well.

Inquire about company’s funding

You’d think that the more money the company has raised, the better off you are. It indicates a strong company with bright future. Well, things are not that simple. When startups raise money from investors, those investors become owners of preferred stock. There are a number of different types of preferred stock, but in all cases, the holders of these stocks will be paid before you see any money in the case of an exit. Keep in mind that there can be a few rounds of investments, making your payout further and further away.

Inquire about the exercise price

You should never accept any stock options unless the employer is ready to define (in writing) the exercise price of your initial options. This should be part of your Stock Option Agreement, as well as the Offer Letter. Do not fall for the common trick where they tell you that exercise price will be later defined according to the company’s fair market value down the road.

Closing Word

These are just some of the basic inquiries that you should make before you accept any stock options as way of compensation for your work. You should probably learn more about this by reading up on business articles and talking to professionals from the tax, accounting and legal fields. The most important thing to take from this is never to rush into anything.

About the Author: James D. Burbank has seen too many businesses succeed and fail during his days in the trade show industry. He is currently back home, spending time with his family and blogging on BizzMarkBlog.

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