Gaining access to employee stock options is seen as a positive for most employees, even when they aren’t familiar with how stocks operate. Unfortunately, this makes it impossible for them to evaluate the equity of their job offers, which leads to companies playing on their naivete.
The amount of stocks a company holds isn’t as significant as the percentage of the company those options represent or how long their options take to vest, so you can exercise them.
After getting a job with a company that offers stocks as an option for payment or as a benefit, ask the supervisor these 6 questions to determine how fruitful this opportunity truly is for you.
What percentage of the company do employee stock options represent?
The first question is actually the most important. When it comes to stock options, bigger isn’t always better. A company that offers fewer options with a higher percentage of ownership will be the better offer because there’s a possibility their stock will be worth more in the future.
For example, if one company offers 10,000 options out of 1,000,000 shares outstanding, and the other company offers 100,000 with 100,000,000 shares outstanding, the first company is the better offer. You own 1% of the company with the first option but only 0.1% of the second.
Are all shares included in the total shares outstanding?
If the prospective company isn’t disclosing its total amount of shares, that’s an immediate red flag at the offer stage. It means they’re hiding their profit margins, either from you specifically, their entire team, or their shareholders, which isn’t a business you want to work for.
Ask if your company of choice includes the following in the denominator:
- Preferred stock
- Common stock
- Restricted stock
- Warrants
- Options outstanding
- Unissued shares
Once you’ve determined the total shares outstanding, use this employee stock option calculator to determine the full worth of your new position, but only if they’re deemed to be trustworthy.
What is the vesting schedule for my options?
Vesting schedules typically happen over four years with a one-year cliff. This means that employees won’t receive company shares during their first year of employment. After the cliff, companies will allow you to vest 25% of your shares, making your options vest monthly.
If a company offers an extended vesting period or cliff, that’s another red flag. It may mean that they don’t have these options, or their banking on you to quit before you receive these options.
When must I exercise my options? What happens to these options if I leave before the entire vesting schedule is completed?
Companies commonly ask their employees to exercise their options within 90 days of their departure. If the company is successful, that won’t be easy because some of your options may not have a market that you can sell back to for a number of months or even several years.
Ask if the company can either evaluate the exercise period based on your tenure or, preferably, eliminate the requirement. This allows you to take advantage of these options in the long term.
However, if you leave before the vesting schedule completes, or you miss your exercise period, you may be in trouble depending on the company terms. Ask if the company will buy back your shares upon your departure if you leave before they have a business-wide liquidity event.
If this is the case, your shares won’t be worth anything in two to three years. Only stay with companies that agree to let you keep or directly sell your options once you decide to leave.
Is acceleration an option if the company is acquired?
Companies are acquired all the time, but when your stocks are tied up with said company, you’ll have no choice but to stay. Ask if the company has an option to accelerate if they’re acquired.
Some companies won’t offer acceleration because the acquirer will often pay a lower acquisition price. Still, it doesn’t hurt to ask because if you’re fired or laid-off when the company is acquired, you may have to go through an additional vesting period for your stock options.
How and when do you do stock appraisals?
Venture capital-backed startups issue options to employees at a fraction of what investors pay, but that can get you in trouble. While you are looking for a big discount, you don’t want one so large that it signals to the IRS that you’re up to no good, even if it has nothing to do with you.
Ask if the company uses fully diluted shares outstanding for their calculations and when their last 409A appraisal was. If it’s been a while since their last appraisal (longer than six months), it’s likely your exercise price will rise, which will often make your options less valuable.
Wrapup
Knowing the results of a stock appraisal can also help you determine the approximate value of the company. If their assessment worries you, it’s a sign they’re not profitable and may default.
