5 ms·

One way to figure it out is to calculate what the 5% is worth. Here's a very rough/inaccurate calculation - that ignores option prices etc - that might give you

by malanj 11y ago

One way to figure it out is to calculate what the 5% is worth. Here's a very rough/inaccurate calculation - that ignores option prices etc - that might give you an idea: Lets say the company's post seed valuation is $3m (random guess). So 5% is $150k. Your shares probably vest for 4 years, so that's ~$40k/year of shares. Given that you're (most likely) getting ordinary stock (not preferred), you should discount that $40k quite heavily. In short: it's probably not a bad offer, but definitely comparable with your current compensation.

kjksf 11y ago
It's a good explanation but what should also be mentioned that you have a very high (let's say 90%) probability that you won't see any money from those options. In economic terms this is called expected value and assuming 10% of success, expected value of the options would be $150k * 0.1 i.e. $15k.
- hollerith 11y ago
  >assuming 10% of success, expected value of the options would be $150k * 0.1 i.e. $15k. That is wrong because the post-seed valuation ($3m) already has the risk of failure baked into it. i.e., those investing at that valuation already know about the high risk of failure. If the startup had a 100% chance of success and the seed-stage investors could be convinced of that fact, the post-seed valuation would have been about ten times higher. Your calculation would be correct if $3m were what the company would be worth if it succeeds, but it is not.
  - TuringNYC 11y ago
    Not quite -- those investing are valuing your company at that in light of [probably] having an entire basket of companies, so they have the benefit of averages. As an employee, you have one shot at this, so the risk is far higher due to lack of diversification.
    - rahimnathwani 11y ago
      Lack of diversification doesn't play into the calculation of expected value. The expected value of 100% chance of $1m is the same as the expected value of 1% chance of $100m. If you're an individual trying to make a utility-based decision, though, you have to take into account the diminishing marginal utility of each additional dollar, i.e. you care much more about the first $1m than the next $1m.
vs2370 11y ago
thanks, can you plz elaborate on preferred shares? how will that change the math...
- rgovind 11y ago
  I believe if you have ordinary stock, it will get diluted during subsequent funding rounds. Preferred stock may not
- malanj 11y ago
  You can think of preferred stock as both a loan and shares. If the current valuation is $3m and you have 10% preferred stock, then you have the choice of taking your loan back ($300k) or keeping your shares. If things go well (company value increases), then you have to take the stock. However, if things don't go well, you get to take all of your money back before any common shareholders get any money. So in marginal cases (where the company doesn't become very valuable), common stock tends to be worthless and preferred stock still has a chance of having some value.
  - vs2370 11y ago
    thanks again.. so basically if I negotiate to get preferred stock and if the company gets valued at 100 million, I can cash out 5 million since it would not get diluted with subsequent funding rounds..
    - TuringNYC 11y ago
      Be careful with the assumption that you can just "cash out" -- firstly some companies simply will not let you...you are stuck with the equity for 10+ years until an IPO. If you are allowed to sell, selling in the private market is not as easy as eTrade -- you will pay a big commission and you only get what someone is willing to pay. See http://www.ft.com/intl/cms/s/0/27e9444c-0879-11e5-85de-00144feabdc0.html#axzz3jcuUW6A9 http://www.ft.com/intl/cms/s/0/27e9444c-0879-11e5-85de-00144...
    - rahimnathwani 11y ago
      I have never heard of someone being granted preferred stock in a startup, except in return for cold hard cash. Part of the rationale of preferred stock is to protect investors from the CEO just selling the company tomorrow and taking home a large % of the cash in the bank.

by malanj 11y ago

kjksf 11y ago

It's a good explanation but what should also be mentioned that you have a very high (let's say 90%) probability that you won't see any money from those options. In economic terms this is called expected value and assuming 10% of success, expected value of the options would be $150k * 0.1 i.e. $15k.

hollerith 11y ago
>assuming 10% of success, expected value of the options would be $150k * 0.1 i.e. $15k. That is wrong because the post-seed valuation ($3m) already has the risk of failure baked into it. i.e., those investing at that valuation already know about the high risk of failure. If the startup had a 100% chance of success and the seed-stage investors could be convinced of that fact, the post-seed valuation would have been about ten times higher. Your calculation would be correct if $3m were what the company would be worth if it succeeds, but it is not.
- TuringNYC 11y ago
  Not quite -- those investing are valuing your company at that in light of [probably] having an entire basket of companies, so they have the benefit of averages. As an employee, you have one shot at this, so the risk is far higher due to lack of diversification.
  - rahimnathwani 11y ago
    Lack of diversification doesn't play into the calculation of expected value. The expected value of 100% chance of $1m is the same as the expected value of 1% chance of $100m. If you're an individual trying to make a utility-based decision, though, you have to take into account the diminishing marginal utility of each additional dollar, i.e. you care much more about the first $1m than the next $1m.

vs2370 11y ago

thanks, can you plz elaborate on preferred shares? how will that change the math...

rgovind 11y ago
I believe if you have ordinary stock, it will get diluted during subsequent funding rounds. Preferred stock may not
malanj 11y ago
You can think of preferred stock as both a loan and shares. If the current valuation is $3m and you have 10% preferred stock, then you have the choice of taking your loan back ($300k) or keeping your shares. If things go well (company value increases), then you have to take the stock. However, if things don't go well, you get to take all of your money back before any common shareholders get any money. So in marginal cases (where the company doesn't become very valuable), common stock tends to be worthless and preferred stock still has a chance of having some value.
- vs2370 11y ago
  thanks again.. so basically if I negotiate to get preferred stock and if the company gets valued at 100 million, I can cash out 5 million since it would not get diluted with subsequent funding rounds..
  - TuringNYC 11y ago
    Be careful with the assumption that you can just "cash out" -- firstly some companies simply will not let you...you are stuck with the equity for 10+ years until an IPO. If you are allowed to sell, selling in the private market is not as easy as eTrade -- you will pay a big commission and you only get what someone is willing to pay. See http://www.ft.com/intl/cms/s/0/27e9444c-0879-11e5-85de-00144feabdc0.html#axzz3jcuUW6A9 http://www.ft.com/intl/cms/s/0/27e9444c-0879-11e5-85de-00144...
  - rahimnathwani 11y ago
    I have never heard of someone being granted preferred stock in a startup, except in return for cold hard cash. Part of the rationale of preferred stock is to protect investors from the CEO just selling the company tomorrow and taking home a large % of the cash in the bank.