a canadian startup

Explaining Employee Stock Options

We startup people often tell potential hires: “Plus we give options” — but we seldom explain what that means.

You’re welcome to ask.

Here’s an email I might send to an applicant if I worked at a typical startup and was asked about the meaning of options:

Some links to read:

http://www.genuinevc.com/archiv…

http://www.burningdoor.com/ask…

http://www.askthevc.com/blog/…

http://www.payne.org/index.ph…
(but if you actually ask the questions from this last article, don’t expect a reply ;) )

My advice to people joining is always to NEVER think about stocks as a way to buttress salaries because it’s such a gamble and it’s so indeterminate. It’s more a treat — and definitely not a smart way to get rich.

First we’re trained to scare people: more than 50% of startups fail.

In an article by the CEO of Redfin, he says:

“…an engineer said the only thing he remembered from his interview was our saying the most likely outcome for Redfin–or any startup–was bankruptcy, but that he should join us anyway. It’s odd but the more we’ve tried to warn people about the risks, the more they seem to ignore them. And since you have to keep taking risks, you have to keep telling people about them.”

A startup company will often dole out options to new employees with a current value of about $XXXXX but the idea is that as a startup, and being a newly invested thing with the first issue of options, values of stocks are expected (read: hoped) to grow at multiples of 3X, 4X or 5X up to 10X by exit or IPO (if there is a planned exit or IPO). Investors come in because they are hoping for numbers like this. But this is something that we never say explicitly — why, because this is a terrible thing to count on — it’s better that employees take options (at this stage) more for the fun “we’re in this ride together — if things go well, we all get a big cheque”.

The other variable to think about is that options have vesting terms — usually this means that employees get the first 1/4 of their options converted to stocks only after year 1, the second quarter by year 2, etc.

It’s important to ask these questions — let me know if you have any others or if I was unclear. I am learning about all this stuff myself.

[options, of course, come with a bunch of legal info -- this email is not a substitute for that, it's just general, off-the-top-of-my-head advice -- consult your lawyer, blah blah blah]

-ali

If you apply to work for a larger, later stage startup, you might be able to guess at the potential value for options, along with the estimated risk. For early stage companies, no honest CEO can predict that — there are just too many variables.

So:

Early, early, early stage employee stock options are for one thing. They are a message to employees. “We consider you to be so valuable, that we want you to to own a part of the company.” They are a perk and they are symbolic, but they can’t justifiably be considered compensation (not yet).

Cuz who knows.

But between you and me, yeah, these options are going to be worth a bajillion dollars. You can write that down. A bajillion and a half, maybe.