A checklist for stock option offers

February 2019

A friend of mine was looking at some job offers from startups recently and asked me for advice on how to think about the equity awards he was offered.

This depends a lot on details that companies often don’t give you unless you ask. So I ended up writing up the email I’d send asking for all the tricky details on any equity offer–plus instructions on how to interpret the response.


Before you ask for any tricky details, there are two questions you need to answer on your own:

The checklist email

If I had job offers whose equity I was evaluating, here’s the info I’d ask for, in convenient email format:

Hi $NAME,

Really excited about the opportunity to work at $COMPANY! I just have a few questions about the equity offer to help me figure out how to value it:

(Feel free to copy and paste it for your own negotiations! And you should probably be also asking about the company’s metrics and financial health, but that’s for another post.)

PS: If you have suggestions for other questions, or relevant stories or data points, please comment below! If you’d prefer them to stay private you can also email me.

Reasoning

Here’s the reasoning behind each piece of info, and how I’d interpret the answer:

Valuing the offer

If the company refuses to give you any of this information, it’s a huge red flag: they don’t care or don’t want you to be able to value the options effectively, probably because the options aren’t actually very valuable.

If they answer your questions, and the first answer is “90 day expiry window,” you have three options:

If they have a reasonable expiry window or you decide to early exercise, you then have to figure out the actual expected value of the option package. In principle, this is a simple formula:

options expected value = number of shares × (expected value per share − probability of success × per-share strike price)

Of course, you have no idea what the “expected value per share” or “probability of success” values are!

In practice, for early stage startups the probability of success and strike price are usually low enough that you can ignore that term. For late stage startups, though, it can matter a lot, so be careful.

Expected value per share is the harder one. The safest way to guess it is by appealing to the efficient-market hypothesis: assume that the company’s venture investors paid a fair price, and value your share based on that.

The tricky part you can only assume the VCs paid a fair price for their stock, which comes with more protections than yours. That’s why you need to know the actual investment terms. The study I cited in my previous discussion found that common stock was worth between 0% and 66% less than VCs’ stock, depending on the terms. Here’s my guess at a rule of thumb:


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Anonymous

Thanks for the article, it’s a very good and concise summary. I don’t understand the - probability of success × per-share strike price term in the formula though - how can options expected value go down if probability of success goes up?

Ben

If the probability of success goes up, you’re more likely to have to exercise your options, and that term is the price you paid to exercise them.

It’s a bit confusing the way I wrote it because the decrease is always outweighed due to the increase in the expected value per share term, which has probability of success baked in. A clearer rendering might be:

options expected value = number of shares × probability of success × (expected share price given success − per-share strike price)

but this doesn’t make it as obvious that you can effectively ignore the strike price for early-stage options.

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