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Monday, August 23rd, 2010

Questions For You To Ask About Stock Options As Compensation

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If you’re considering a new job, salary is of course important…but don’t forget about equity (especially in Internet/Silicon Valley-oriented companies).

Here are the simple questions to ask related to stock (I’m gonna keep this simple and limit discussion to stock options):

  • Can stock options be part of my compensation program?

If the answer is “yes,” than you move on to these basic questions:

  • How many stock options will be offered to this position?
  • What are the total number of shares currently outstanding? (this allows you to calculate the % of the company you could own)
  • What are the total number of shares that the company is authorized to issue? (this tells you what % of the company you’d own if they issued new new shares)
  • What is the current exercise price of the stock options? (this will usually be a low price unless it’s a publicly-traded company (in which case you have little to worry about because you will only be exercising the right to buy the stock if you’re going to sell it for a price that is known to the public (and which will be higher than the amount you’re paying).
  • How do the stock options vest? (this is the period of time through which they vest and at what rate (often, the shares vest over 4 years but with a one-year cliff (meaning that if you leave in less than 12 months, you would have zero stock vested but if you stay 2 years than you would have half of the shares vested).
  • What is the current valuation of the company?

Let’s say that the answer is that they can offer you 20,000 stock options for a strike price of $.01 each (i.e $200 total cost if you every exercised the options).

And let’s say that there are 1 million shares outstanding but another 1 million are authorized to issued (i.e. there are 2 million shares that may be outstanding one day).

Then, your 20,000 stock options would account for 2% of the currently outstanding shares or 1% of the shares that could be outstanding one day.

If the current valuation of the company (remember, you asked for this too) is $5 million, then you’re stock are worth at the low end 1% of the $5 million or $50,000 minus the $200 you’d have to pay to exercise the options (and, of course, minus whatever the capital gains taxes are at that time).

If you or other smart folks believe that the value of the company is going to increase (let’s say to $100 million within 4 years), then your 20,000 stock options (which should account for 1%+ of the biz) would be worth around $1 million.

That’s the basics of how stock option compensation works.

Good luck!

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