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Your analysis points to why the authors analysis is flawed. He calculates the expected value of the option and says that this leaves the value of the stock opti

Your analysis points to why the authors analysis is flawed. He calculates the expected value of the option and says that this leaves the value of the stock options to be very small. What he neglects to mention is that the employee is also granted a 'real option' which is his right, but not obligation, to leave the company if it does badly. This 'real option' significantly increases the value of stock options because the employee can leave after one year (or less) in the case that the startup is not on track to succeed. This means the forgone salary is reduced in the down scenario. Google 'real options' or 'strategic options' for the maths behind how to price these, it's a beautiful mathematical theory.

boxerbk 13y ago
100% agree. This is definitely a simple analysis meant to give people an idea what the value of their options is. I'm going to caveat the rest of this comment with my very little understanding of real options. I've only worked with a real option calculator once about 6 years ago. with that being said, here's my thinking on real options: You can do a much better analysis with a real options calculator, but you would have to make a lot of assumptions in your real option calculator about the different branches the individual could travel down at each node. At some point you could say that there is some very unlikely probability that this job allowed the person to travel down a path in 5 years that enabled them to start their own company and IPO'd that company. This would have an impact on the value of the options offered today, but I cannot imagine all of the possibilities of a real option calculator.
codex 13y ago
Another point further complicating the analysis is that companies which start to do really well simply turn around and reduce the amount of subsequent grants. There is less risk of failure; the expected value of the grant has increased, so the company offers fewer shares to existing employees in the next grant cycle. This effect can be significant as growth companies tend to hire a lot of people (including hot shot VPs with huge price tags) and take more rounds of funding, both of which can dilute initial grants substantially before the liquidity event. The author assumes no subsequent grants, but realistically everybody factors subsequent grants into their back of the envelope calculations.
bjornsing 13y ago
I agree this is an important aspect to consider. However I don't think it would affect the OP's estimate of the value of the option grant itself. It would instead affect the price payed by accepting a below market salary. I.e. the 'real option to leave' can affect the ROI but not absolute return.

boxerbk 13y ago

100% agree. This is definitely a simple analysis meant to give people an idea what the value of their options is. I'm going to caveat the rest of this comment with my very little understanding of real options. I've only worked with a real option calculator once about 6 years ago. with that being said, here's my thinking on real options: You can do a much better analysis with a real options calculator, but you would have to make a lot of assumptions in your real option calculator about the different branches the individual could travel down at each node. At some point you could say that there is some very unlikely probability that this job allowed the person to travel down a path in 5 years that enabled them to start their own company and IPO'd that company. This would have an impact on the value of the options offered today, but I cannot imagine all of the possibilities of a real option calculator.

codex 13y ago

Another point further complicating the analysis is that companies which start to do really well simply turn around and reduce the amount of subsequent grants. There is less risk of failure; the expected value of the grant has increased, so the company offers fewer shares to existing employees in the next grant cycle. This effect can be significant as growth companies tend to hire a lot of people (including hot shot VPs with huge price tags) and take more rounds of funding, both of which can dilute initial grants substantially before the liquidity event. The author assumes no subsequent grants, but realistically everybody factors subsequent grants into their back of the envelope calculations.

bjornsing 13y ago

I agree this is an important aspect to consider. However I don't think it would affect the OP's estimate of the value of the option grant itself. It would instead affect the price payed by accepting a below market salary. I.e. the 'real option to leave' can affect the ROI but not absolute return.