4 ms·

How often is the strike price the fair market value of the employee equity pool? Most VCs carry preference stacks to either 1x or 2x of the current valuation,

by lumost 6y ago

How often is the strike price the fair market value of the employee equity pool? Most VCs carry preference stacks to either 1x or 2x of the current valuation, Leaving the options structurally underwater unless the company increases in value by 3x. To take home the strike price equivalent per option could require up to a 6x increase in valuation. This is a non-obvious way that employees are often screwed on options.

dbt00 6y ago
The “at a valuation of” numbers you see thrown around in funding rounds are preferred shares and have a higher cost than employee equity. As a result, companies can use that risk factor to push down on employee strike price, aka 409(a) valuation of common shares, to keep buy in costs low until a liquidity event that equalizes risk preferences (or, if it’s a crappy exit, doesn’t). The company and employees have a common interest in keeping that price low.
- lumost 6y ago
  Unfortunately the only options I've seen in 2 private companies were post-preference with a strike price tied to the valuation of the common equity. At the end of the day the company is acquired for a fixed price which goes to the preferenced shares first, leaving little on the table. Straight IPOs have become rare, and the few times I've been a part of one my grants per year increased following IPO as the value was clear. It's possible there was a mechanic at work that would have made the equity worth more at the ~6x valuation increase, however these companies were already worth ~200 million-1 billion. If the company wanted to incentivize extreme upside they should have increased the strike price, and increased the number of options granted. Spotify provides this option to employees where you can choose cash, RSUs, options, or "high-risk" options. You can get 8x options relative to RSUs with a strike price that's double the current stock price. If the company 4x'd in value over 4 years you'd make 4x on these compared to RSU's enabling a public company to offer "lottery" ticket equity packages. Ultimately if a startup is trying to offer a lottery ticket to employees to lure them from top-tier companies, then they'll need to make real lottery tickets with real payouts at the end. That means that a startup with an expected 100 million dollar exit in 5 years will need to grant 2% of the company at exit to a top-tier engineer in the average case ( with appropriate vesting ).
jiveturkey 6y ago
> How often is the strike price the fair market value of the employee equity pool? Always. If by FMV you mean 409(A) valuation. If you mean something else, the answer is 'never' because for privately held companies we don't know the "fair market value". Your point about VCs seems irrelevant, because the valuation they hold shares at is not that of the "employee equity pool". To take home a strike price equivalent per option requires only 2x (to cover taxes) increase over your strike price, and for the equity to be tradeable. This is not a simple calculation, as implied by your 3X/6X multiple. If you only took home a strike price equivalent per option, you'd never, ever, ever take one of these jobs. Options are priced at 409(A) and for the type/stage of company we're talking about here, are typically 2%-10% of the preferred price. IOW, incredibly low-valued. I don't think you're wrong. I think your comment is malformed.
- lumost 6y ago
  That's completely fair. Does this math change depending on the exit though? e.g. When the company IPOs or is bought out, the preference pool and the employee pool has to be merged. The implication of your comment is that the slope of the employee gain once the preferenced shares have met their obligations will be substantially higher than in my math above. On the other hand, subsequent rounds increase the number of outstanding preference shares and your employee strike price could have been set at a time when all preferences would be satisfied, The math will then shift back to a 6x required gain (for a strike price equivalent). On a 10-year liquidity horizon, the employee option pool can be pushed into the underwater state by subsequent issuance of preferenced shares. In my Experience, this effect explains how startup employees who have stayed with a firm from 10 million dollar valuations to Billion+ valuations do not get anything better than a down payment for their trouble, and a 3x increase in a publicly traded companies stock can easily push an engineer's RSUs to 1.5x+ their salary per year.
  - jiveturkey 6y ago
    Thanks for the followup, much more well formed. To a few specific points: > the slope of the employee gain once the preferenced shares have met their obligations will be substantially higher than in my math above. Yes. This is all but required by "the rules". > subsequent rounds increase the number of outstanding preference shares Yes, but by lesser and lesser amounts of dilution, and at higher and higher valuations. Ignoring down rounds, which are much more common than up rounds. But here I think we are talking about a "successful" exit, which as rare as they are, in the majority still leave option holders high and dry anyway. > your employee strike price could have been set at a time when all preferences would be satisfied, The math will then shift back to a 6x required gain (for a strike price equivalent). True, however in these cases almost everyone (actually everyone, AFAIK) receives RSUs, not options. RSUs have an actual, current value, and do not require any appreciation in price at all. In fact, a loss in price is still valuable to the holder. You can't go underwater with RSUs. (And you can't face uncertain taxes; be forced to make awful decisions; etc.) > On a 10-year liquidity horizon, This is the real problem with equity compensation today. We've outgrown the system under which options were a great incentive. Golden handcuffs, that most exceedingly often, turn into fool's gold. Honestly, it's time for YC to insist on 10 year termination-exercise rights. The appeal of ISOs is still there for early stage companies, but AIUI one can convert from ISOs to NQ's after the 90 day legal requirement, without penalty. win-win. With a 10 year rights, companies are forced to offer sufficient refreshers to keep staff. This is completely fair and will push companies to earlier exits. On the employee side, people need to insist on it as well ... I don't see it happening because it destroys the VC business model.

by lumost 6y ago

dbt00 6y ago

The “at a valuation of” numbers you see thrown around in funding rounds are preferred shares and have a higher cost than employee equity. As a result, companies can use that risk factor to push down on employee strike price, aka 409(a) valuation of common shares, to keep buy in costs low until a liquidity event that equalizes risk preferences (or, if it’s a crappy exit, doesn’t). The company and employees have a common interest in keeping that price low.

lumost 6y ago
Unfortunately the only options I've seen in 2 private companies were post-preference with a strike price tied to the valuation of the common equity. At the end of the day the company is acquired for a fixed price which goes to the preferenced shares first, leaving little on the table. Straight IPOs have become rare, and the few times I've been a part of one my grants per year increased following IPO as the value was clear. It's possible there was a mechanic at work that would have made the equity worth more at the ~6x valuation increase, however these companies were already worth ~200 million-1 billion. If the company wanted to incentivize extreme upside they should have increased the strike price, and increased the number of options granted. Spotify provides this option to employees where you can choose cash, RSUs, options, or "high-risk" options. You can get 8x options relative to RSUs with a strike price that's double the current stock price. If the company 4x'd in value over 4 years you'd make 4x on these compared to RSU's enabling a public company to offer "lottery" ticket equity packages. Ultimately if a startup is trying to offer a lottery ticket to employees to lure them from top-tier companies, then they'll need to make real lottery tickets with real payouts at the end. That means that a startup with an expected 100 million dollar exit in 5 years will need to grant 2% of the company at exit to a top-tier engineer in the average case ( with appropriate vesting ).

jiveturkey 6y ago

> How often is the strike price the fair market value of the employee equity pool? Always. If by FMV you mean 409(A) valuation. If you mean something else, the answer is 'never' because for privately held companies we don't know the "fair market value". Your point about VCs seems irrelevant, because the valuation they hold shares at is not that of the "employee equity pool". To take home a strike price equivalent per option requires only 2x (to cover taxes) increase over your strike price, and for the equity to be tradeable. This is not a simple calculation, as implied by your 3X/6X multiple. If you only took home a strike price equivalent per option, you'd never, ever, ever take one of these jobs. Options are priced at 409(A) and for the type/stage of company we're talking about here, are typically 2%-10% of the preferred price. IOW, incredibly low-valued. I don't think you're wrong. I think your comment is malformed.

lumost 6y ago
That's completely fair. Does this math change depending on the exit though? e.g. When the company IPOs or is bought out, the preference pool and the employee pool has to be merged. The implication of your comment is that the slope of the employee gain once the preferenced shares have met their obligations will be substantially higher than in my math above. On the other hand, subsequent rounds increase the number of outstanding preference shares and your employee strike price could have been set at a time when all preferences would be satisfied, The math will then shift back to a 6x required gain (for a strike price equivalent). On a 10-year liquidity horizon, the employee option pool can be pushed into the underwater state by subsequent issuance of preferenced shares. In my Experience, this effect explains how startup employees who have stayed with a firm from 10 million dollar valuations to Billion+ valuations do not get anything better than a down payment for their trouble, and a 3x increase in a publicly traded companies stock can easily push an engineer's RSUs to 1.5x+ their salary per year.
- jiveturkey 6y ago
  Thanks for the followup, much more well formed. To a few specific points: > the slope of the employee gain once the preferenced shares have met their obligations will be substantially higher than in my math above. Yes. This is all but required by "the rules". > subsequent rounds increase the number of outstanding preference shares Yes, but by lesser and lesser amounts of dilution, and at higher and higher valuations. Ignoring down rounds, which are much more common than up rounds. But here I think we are talking about a "successful" exit, which as rare as they are, in the majority still leave option holders high and dry anyway. > your employee strike price could have been set at a time when all preferences would be satisfied, The math will then shift back to a 6x required gain (for a strike price equivalent). True, however in these cases almost everyone (actually everyone, AFAIK) receives RSUs, not options. RSUs have an actual, current value, and do not require any appreciation in price at all. In fact, a loss in price is still valuable to the holder. You can't go underwater with RSUs. (And you can't face uncertain taxes; be forced to make awful decisions; etc.) > On a 10-year liquidity horizon, This is the real problem with equity compensation today. We've outgrown the system under which options were a great incentive. Golden handcuffs, that most exceedingly often, turn into fool's gold. Honestly, it's time for YC to insist on 10 year termination-exercise rights. The appeal of ISOs is still there for early stage companies, but AIUI one can convert from ISOs to NQ's after the 90 day legal requirement, without penalty. win-win. With a 10 year rights, companies are forced to offer sufficient refreshers to keep staff. This is completely fair and will push companies to earlier exits. On the employee side, people need to insist on it as well ... I don't see it happening because it destroys the VC business model.