4 ms·

I'm surprised the post doesn't mention a specific type of risk which is out of your control. I'm not well versed in options lingo, is there something to descri

by nickjj 3y ago

I'm surprised the post doesn't mention a specific type of risk which is out of your control. I'm not well versed in options lingo, is there something to describe this scenario? You join with a very low strike price, such as $0.05 and get a lot of shares, let's say 200k to keep the math easy. At that strike price the value on paper is $10,000. Then a liquidity event occurs before your options vest and now instead of 200k shares @ $0.05 you have 3,333 shares at $3.00 because the valuation of the company changed. You still have $10,000 in options. The issue now is you've taken a huge loss in the multiplier effect. Having a stock go from $0.05 to $1 is a 20x jump. Hitting that would yield $200,000 in value. But the odds of $3 turning into $60 is so much lower, but that's what you would need the stock to hit to yield the same return in the end. In the end, over time you tend to get less stocks at a higher adjusted strike price with no real-world opportunity to exercise. Sometimes even if you have vested options you can only exercise a single digit percentage of your total shares so the total cash-out value is the equivalent of 1 day's worth of pay even after years of vested options.

seanhunter 3y ago
> Then a liquidity event occurs before your options vest and now instead of 200k shares @ $0.05 you have 3,333 shares at $3.00 because the valuation of the company changed. You still have $10,000 in options. A liquidity event wouldn't change your number of options in general. If you had 200k options before the liquidity event and you didn't sell any when the event happened, you still have 200k options after and their strike price doesn't change. The value of these options has changed because the value of the underlying stock has changed. It's absolutely not the case that your options get adjusted to keep the dollar value the same post-liquidity event unless there is a consolidation as described below. Your terminology is a bit imprecise so it's hard to be 100% sure what you mean but I think you're talking about dilution. It doesn't work quite the way you wrote it down but the net effect is similar to how you describe as long as you think in percentage terms rather than number of shares at a price terms. Say your 200k shares represents 1% of the company (so there are 20m shares) and an investor comes in and puts in 20m for 50% of the company. This values the company at 40m (post money) but dilutes you so now your 200k shares is only 1/2% of the company. In theory whether this is good or bad depends entirely on the true value of the company relative to the price the investor came in for. If the company is worth exactly 40m with the new money then it's easy to say that it must be worth 20m before the money (because it's just the same company but has been given $20m), and 1/2% of a company worth $40m is exactly the same as 1% of a company worth %20. In practise your position is generally worse afterwards because the investor will usually get a "liquidity preference" which means they will get all their money out before you get a dime. So you have a smaller percentage and your position on the cap table is a bit worse than it was before. The hope is that the money and whatever else the investor brings to the table makes the whole thing better in a way that compensates for that. There is one other scenario which can play out a bit like what you mentioned, which is a "reverse split" (also sometimes called a consolidation). This is somewhat rare and usually is only going to happen when the company isn't doing that great. So a split is where say the company has 100mil shares at $10 per share they split each of those into 10 new shares at $1 per share so if you had 200k options at 0.05, you now have 2m options at 0.005. Well a reverse split is the opposite of that so your 200k options at 0.05 become 20k options at 0.5 in the case of a "1 for 10" consolidation. Your stuff about the multiplier effect is not really how stock trading works. Market professionals think in terms of percentages in general, so having a stock go from $3 to $60 is exactly the same as having it go from $0.05 to $1.[1] When you say about only being able to exercise a certain percentage of vested stock - those restrictions are real but generally affect things more pre-IPO (and for a short lock-in period post-IPO) but in general exercise pre-IPO is very limited. But yes those sorts of restrictions are important and it's important to read your options agreement carefully to make sure you understand them. [1]One exception to this is "Pink Sheet" stocks which happen to be both very low-priced per share and very volatile. The reason they are so volatile is that because of their low price they can't get a normal stock listing and so are extremely illiquid and subject to fraud and market manipulation etc in ways that are more extreme than normal stocks. Stocks with extremely low prices like this could do a reverse split to get their price into a normal range but choose not to, which leads most people to think they prefer to avoid normal market scrutiny. The other exception are stocks like Berkshire Hathaway which are illiquid because they are so high-priced (per share). They could fix this problem by executing stock splits but Warren Buffett has had a sort of religious objection to doing this. It's irrational and it hurts liquidity in this stock.
- nickjj 3y ago
  > A liquidity event wouldn't change your number of options in general. If you had 200k options before the liquidity event and you didn't sell any when the event happened, you still have 200k options after and their strike price doesn't change. It did change. A new higher strike price was set and the share count was reduced so the $ value was the same in the end. > Your stuff about the multiplier effect is not really how stock trading works. Market professionals think in terms of percentages in general, so having a stock go from $3 to $60 is exactly the same as having it go from $0.05 to $1. Sure, the percentage is the same but isn't it "easier" for a stock to go from $1 to $3 vs $100 to $300? The 2nd one means the stock's value needs to jump by $200 but the first one is only $2. It seemed like a mechanism to control the multiplier effect from producing a very high return.
  - seanhunter 3y ago
    That sucks. Yeah that's a consolidation and generally it's not good news.
    - nickjj 3y ago
      Thanks. When Googling for that, it's finding a lot of general consolidation definitions. Throwing in terms like liquidity event, strike price adjustment, etc. didn't narrow it down to something that looked relatable. Is there a specific name or way to categorize this type of consolidation for the example I provided?

by nickjj 3y ago

seanhunter 3y ago

> Then a liquidity event occurs before your options vest and now instead of 200k shares @ $0.05 you have 3,333 shares at $3.00 because the valuation of the company changed. You still have $10,000 in options. A liquidity event wouldn't change your number of options in general. If you had 200k options before the liquidity event and you didn't sell any when the event happened, you still have 200k options after and their strike price doesn't change. The value of these options has changed because the value of the underlying stock has changed. It's absolutely not the case that your options get adjusted to keep the dollar value the same post-liquidity event unless there is a consolidation as described below. Your terminology is a bit imprecise so it's hard to be 100% sure what you mean but I think you're talking about dilution. It doesn't work quite the way you wrote it down but the net effect is similar to how you describe as long as you think in percentage terms rather than number of shares at a price terms. Say your 200k shares represents 1% of the company (so there are 20m shares) and an investor comes in and puts in 20m for 50% of the company. This values the company at 40m (post money) but dilutes you so now your 200k shares is only 1/2% of the company. In theory whether this is good or bad depends entirely on the true value of the company relative to the price the investor came in for. If the company is worth exactly 40m with the new money then it's easy to say that it must be worth 20m before the money (because it's just the same company but has been given $20m), and 1/2% of a company worth $40m is exactly the same as 1% of a company worth %20. In practise your position is generally worse afterwards because the investor will usually get a "liquidity preference" which means they will get all their money out before you get a dime. So you have a smaller percentage and your position on the cap table is a bit worse than it was before. The hope is that the money and whatever else the investor brings to the table makes the whole thing better in a way that compensates for that. There is one other scenario which can play out a bit like what you mentioned, which is a "reverse split" (also sometimes called a consolidation). This is somewhat rare and usually is only going to happen when the company isn't doing that great. So a split is where say the company has 100mil shares at $10 per share they split each of those into 10 new shares at $1 per share so if you had 200k options at 0.05, you now have 2m options at 0.005. Well a reverse split is the opposite of that so your 200k options at 0.05 become 20k options at 0.5 in the case of a "1 for 10" consolidation. Your stuff about the multiplier effect is not really how stock trading works. Market professionals think in terms of percentages in general, so having a stock go from $3 to $60 is exactly the same as having it go from $0.05 to $1.[1] When you say about only being able to exercise a certain percentage of vested stock - those restrictions are real but generally affect things more pre-IPO (and for a short lock-in period post-IPO) but in general exercise pre-IPO is very limited. But yes those sorts of restrictions are important and it's important to read your options agreement carefully to make sure you understand them. [1]One exception to this is "Pink Sheet" stocks which happen to be both very low-priced per share and very volatile. The reason they are so volatile is that because of their low price they can't get a normal stock listing and so are extremely illiquid and subject to fraud and market manipulation etc in ways that are more extreme than normal stocks. Stocks with extremely low prices like this could do a reverse split to get their price into a normal range but choose not to, which leads most people to think they prefer to avoid normal market scrutiny. The other exception are stocks like Berkshire Hathaway which are illiquid because they are so high-priced (per share). They could fix this problem by executing stock splits but Warren Buffett has had a sort of religious objection to doing this. It's irrational and it hurts liquidity in this stock.

nickjj 3y ago
> A liquidity event wouldn't change your number of options in general. If you had 200k options before the liquidity event and you didn't sell any when the event happened, you still have 200k options after and their strike price doesn't change. It did change. A new higher strike price was set and the share count was reduced so the $ value was the same in the end. > Your stuff about the multiplier effect is not really how stock trading works. Market professionals think in terms of percentages in general, so having a stock go from $3 to $60 is exactly the same as having it go from $0.05 to $1. Sure, the percentage is the same but isn't it "easier" for a stock to go from $1 to $3 vs $100 to $300? The 2nd one means the stock's value needs to jump by $200 but the first one is only $2. It seemed like a mechanism to control the multiplier effect from producing a very high return.
- seanhunter 3y ago
  That sucks. Yeah that's a consolidation and generally it's not good news.
  - nickjj 3y ago
    Thanks. When Googling for that, it's finding a lot of general consolidation definitions. Throwing in terms like liquidity event, strike price adjustment, etc. didn't narrow it down to something that looked relatable. Is there a specific name or way to categorize this type of consolidation for the example I provided?