Nivi · July 16th, 2008
We’ve been answering this question a lot lately:
“I have a job offer at a startup, am I getting a good deal?”
This isn’t a comprehensive answer—just some questions we would ask if we had an offer.
If you don’t understand your offer, get a lawyer. But—right or wrong—most people don’t hire lawyers to review their offer letter.
Table of Contents
The Offer (answers follow)
- Can you give me the offer in writing?
- How does my compensation compare to my peers in the company?
- What are my options worth?
- What percentage of the company do my options represent on a fully diluted basis?
- Can I exercise my unvested options early?
The Company (see Part 2)
- How much money do you have in the bank right now? How long will it last?
- What was the company’s post-money valuation in the last round?
- What are the investor’s preferences?
- Who is on the board and whom do they represent?
- Would I hire the CEO and board to increase the value of my options?
1. Can you give me the offer in writing?
The only good answers to this question are,
“Yes, an offer is on the way.”
and
“Let’s work out the major points and we’ll give you a written offer. We don’t want to start things off on the wrong foot with an offer that is way off the mark.”
2. How does my compensation compare to my peers in the company?
Some companies pay more, some companies pay less, but an offer is fair if your compensation is in line with you peers’.
Your total compensation consists of salary, options, vesting, cliff, acceleration, bonuses, and severance. And a peer is someone who (1) joined the company at roughly the same time as you did (e.g. halfway between the Series A and Series B) and (2) has roughly the same title you do.
Most employees have a 4-year vesting schedule with a 1-year cliff, no acceleration, no bonuses, and no severance. The exceptions are for Vice-Presidents and higher (and founders).
By the way, your cliff may be longer than the company’s runway, but c’est la vie.
3. What are my options worth?
First you have to know how many options you have and how they vest. Let’s say you have 1000 options and they vest over 4 years. So you get 250 options a year for 4 years.
Now you have to guess what an acquirer would pay for your shares. Let’s call this the acquisition share price. Setting the acquisition share price to the preferred share price of the last round is a good start—let’s say it was $1/share.
Now multiply your options (1000) by the acquisition share price ($1) to calculate the acquisition value of your options: $1000. Since the options vest over 4 years, the annualized acquisition value is $250/year. And while the acquisition value of your options might be $1000 today, you’re naturally hoping that the company’s acquisition share price increases over time.
If the company has gained a lot of value since the last round, you might set the acquisition share price higher than the preferred share price. If the company has not has not done well since the last round, you might set it lower. Either way, you will have to ask the company for the preferred share price in the last round. Or if someone has offered to buy the company for $50M since the last round, I might use $50M to calculate an acquisition share price.
Finally, you will have to pay for your options—they’re not free. Options have a strike price—that’s what you pay for your options. Sometimes it’s much lower than the acquisition share price and can be ignored. Sometimes it’s high and can’t be ignored—high strike prices are becoming more common due to high-valuation rounds (Facebook), founder cash-outs, and high 409A valuations.
4. What percentage of the company do my options represent on a fully diluted basis?
Most people think this number is important—it’s not. You care about the value of your options, not your percentage of the company. Your percentage will decline over time but the value of your options will hopefully increase.
Focus on the how many options you have and the acquisition share price (see question 3 above). Terms like percentage ownership and valuation can fool you.
5. Can I exercise my unvested options early?
This is for advanced Venture Hackers only. Don’t do this without an accountant and/or lawyer.
Exercise your options early if you want to start the clock on capital gains tax eligibility for your stock. Startup pros usually exercise their options early to lower the expected value of the taxes on their stock. In certain cases, you will pay less taxes in an acquisition or IPO if you exercise your options early.
Use an accountant or lawyer. Don’t sue us if this blows up in your face.
This post continues in Part 2.
Related: Other folks who have tackled the topic of “questions to ask before you join a startup”: David Beisel, Dharmesh Shah, and Guy Kawasaki.
Topics Compensation · Employees · Equity · Hiring
So we pay for options, but is equity free? (totally uninformed)
IANAL, but I’m pretty sure the standard alternatives are options or the opportunity to purchase restricted stock. In either case, you don’t own the stock until you pay for it, and you pay the current strike price. Any other arrangement has tax implications, since a company giving you stock counts as income.
What do you mean by equity being free?
Yes, there is a strike price for options. You have to pay for them.
Great stuff! But I’d add a nuance to #3. Multiplying the number of options / shares by the acquisition share price is a good way to estimate the present value of the equity. But, from a financial point of view, the point of joining a startup is not just the expected value but the variance of that equity value.
I think it’s worth at least attempting to model the distribution of the equity value for a time frame corresponding to a plausible stay at the company. Not only does this give you a more meaningful picture of what you might be getting into, but it also helps you later to decide how well the company’s progress is meeting the expectations that drove you to join.
Needless to say, there are a lot of non-financial reasons to join a startup. But it’s always a good idea to figure out the financial component.
Interesting idea… how would you model it?
I’d look for comparables, at least to the extent that I could assume comparable market conditions. And the expected value should still work out to what the investors are paying–that’s a good reality check to keep you honest.
What that really makes you do is gauge the risk / timeline for the company. Are you looking to flip the company in a year for a few million? Or are you hoping to be a $1B company in ten years? Lot of different scenarios work out to the same expected value. I’m not suggesting that you can reliably model the one that applies. But you can try–and that makes you think more about the company’s goals / prospects and your own expectations / aspirations.
Does anyone have an example offer letter? I am curious of the actual format that is “standard” for a good offer letter. I am in the process of hiring 2 executives, and want to make sure all the bases are covered based on the questions above, and how they would be properly identified on the letter. Any examples would be great. Thanks in advance.
Anthony, you should use an offer letter that you got from competent counsel.
Nivi,
I got a decent offer letter from my counsel, but just wanted to make sure it was solid. I am going to run with it though, but always good to double check.
I’ll look into getting an offer letter that I can share.
You can find more discussion about this post on Hacker News.
On No. 5 – Agreed that you don’t want to do this without a lawyer / accountant.
One of the things to worry about is the alternative minimum tax. If you have options with say a $10 strike and the shares have an acquisition value when you exercise of $50, but then the company tanks and the shares go to $5 each, then you are going to owe substantially more taxes than the underlying shares are actually worth. Many people went bankrupt running into this particular shoal during the first bubble.
10 Questions to Ask When Negotiating a Startup Offer — graham randall, ph.d, mba // Jul 25, 2008 at 3:16 pm
[…] Venture Hacks has a great article on questions you need to ask when negotiating your compensation at a startup company. […]
> Finally, you will have to pay for your options—they’re not
> free. Options have an option strike price, a.k.a the fair
> market value of the common stock.
This (at least as things stood in 2005) is inaccurate.
The option strike price and the FMV are independent. The only formal connection between them that I’m aware of is in the case of Incentive Stock Options, which must have a strike price of at least 110% of FMV. That’s as I recall, so you should check if you care.
Non-incentive stock options can have any strike price at all.
Another clarifying point to illustrate the independence: the FMV changes over time and is usually (i.e., between funding events) a somewhat nebulous quantity based on subjective opinions of company worth, but the strike price on an option is fixed and is in no way subject to opinion. The two are not the same thing at all.
Terry,
I removed the mention of fair market value from the article.
The strike price is usually set to the fair market value at the time the options are granted.
Hi Nivi
> The strike price is usually set to the fair market value at the
> time the options are granted.
I wouldn’t even say that, but then again I don’t know the details of that many option agreements.
What’s more common AFAIK, is that strike price is often set to be the FMV of the stock at the time of the last investment.
That can be very different from the current FMV. For example, Google was still (according to a friend encouraging me to join) offering options with a very low strike price just a year before the IPO. That strike price was clearly not the FMV at the time. Also deciding on the official FMV of a stock is a high-level and possibly contentious issue that is sometimes referred to an external and hopefully more objective agent. The IRS might have a different opinion about FMV for tax reasons (you claim it’s low and you owe no tax, they claim it’s high and you do) – e.g., when filing an 83b and claiming that the stock is worth very little. AFAIK, FMV is usually decided on only when really necessary and it’s a board-level decision. It’s not done for each new employee stock option issued.
In public companies the FMV is clear, but even there I don’t think it’s a given that options have FMV as their strike price. I’ve heard of cases either way.
I’m sure you know all this, so I guess in the above you meant that strike price is usually set to the FMV at time of last investment. I just emphasize this because I found the link in your writing between the two to be a bit misleading or less clear than it could be. Apologies if it appears pedantic.
The social dynamics of the company and investors are just as important as the legal issues.
Contracts are never as bulletproof as you think. And even if you had a bulletproof contract, it can cost an awful lot of money to enforce it, especially if the party you are having conflict with has much deeper pockets than you.
One entreprenueurship expert once said, “It is good to write contracts and put them in a drawer. But once they come out of the drawer, everyone loses.”
Use the offer/contract negotiation as an opportunity to assess the personalities of the other people. If the negotiations are ugly, then there is a good chance that if you ever try to exercise the rights the contract gives you, that will be ugly too.
Remember, the whole reason for offering employees stock is to inspire them to work hard for the good of the company. If the offer is not inspiring, then there is a good chance that the company does not know what it is doing and you should walk away.
Hey Nivi, the comment thread here is old, but I have a burning question: I recently read Chris Dixon’s post on startup option packages, and it seems to run directly counter to your advice here.
The article is @: http://www.cdixon.org/?p=467
Would love your thoughts. I always figured the most important numbers are share price and # of shares in an options package, NOT %-age of the company you own, so I’m a little confused!
Thanks!
As a C-level exec. debating an offer from an early stage start up, I found the article and discussion to be really valuable. Not that I know how to truly evaluate the options part of the offer, but at least I know some good questions to ask to get greater clarity.
I think one excellent over-riding thought is that you are not likely to get rich on the equity part of the deal anyway, so don’t get overly hung up on this.
Thanks for the insights.
Comment calculer les options pour un employé dans un startup? – A Frog in the Valley // Nov 22, 2010 at 9:42 am
[…] Si jamais vous êtes dans la situation inverse (l’employé en question et pas l’employeur), Venture Hacks a aussi un très bon recap (encore en anglais): http://venturehacks-dev.mystagingwebsite.com/articles/job-offer. […]