The Employee stock Options offered by Startups : All you need to know

So, really excited to work for a startup company that just offered you a decent package? Its an opportunity to make world a better place to live and an opportunity to get a diverse job experience where everyone jumps in with their sleeves rolled up to get their job done.

But in such cases, the low factor is often a lower salary as the start-up can’t afford to pay higher wages in the early stages. This is often balanced with the offer of an ownership interest through shares or share options.

Let’s get back to the reality. Not every start-up is going to become the next Facebook which, when it went public, made its investors and stock holders millionares. Lets consider Uber, one of the biggest startups in the transport sector. It was founded in 2009, & is yet to go public. In such cases, Is it worth taking a salary cut to get stock options at a hot startup?

For understanding this in detail, we need to understand a few terms: Stock options & vesting.

Lets consider that an employee has been offered 0.1 % equity in a startup. This does not mean that he owns 0.1 percent of the same. The employee is actually given an OPTION to buy those particular number of shares after a particular amount of time. Lets consider that Mr. X joins a startup & he has been given the option to buy 1000 shares of the startup at an exercise rate of 10 dollars per share. The exercise rate is the fair market price of the share which is generally defined by the investors and cofounders. Usually a vesting period is defined which ensures that the employee is linked to the firm for quite some time. Let’s consider that Mr. X has been given a ‘cliff’ vesting period of 1 year and a vesting period of 4 years. This means that only after four years, the employee has full control over those 1000 shares.

Again, we hit the reality which says- 90 % of the startups fail to succeed,while, 95 % startups don’t go for an IPO. But considering the 5% cases left over, Mr. X comes to know that his firm has gone public. So after four years, he exercises his options by paying the exercise price multiplied by the number of shares.(In this case, it would be 1000*10=10000 dollars). Now considering that the share price has significantly increased, Mr. X has finally earned some profit from his stock options!

So, what is the downslide of Employee stock options?

  • In order to exercise your options, you need to pay in cash.
  • At the time you exercise the option, you may incur a tax depending on your alternative minimum tax situation or the type of options you hold.
  • When you exercise the stock options, you will receive stock that will not be easily saleable if the company is still privately held or is subject to substantial transfer restrictions.
  • The value of the stock could go below the exercise price you have paid for the stock (Usually occurs when a startup does not have a successful IPO).

It’s also important to understand that just because you own 0.1 per cent of the company doesn’t mean that you will receive 0.1 percent the amount if the company gets sold to someone. It depends on another factor called Dilution (which I think cannot be explained in detail right now). Different factors can serve to dilute your original shares so that you may still own 0.1 per cent of a certain class of share but the debt and preference shares actually make your equity worth say 0.001 per cent.

Truely speaking, all these downslides boil down to one bitter truth-”Stock options are usually worthless because most startups fail.” But I don’t think that this must stop the employees from accepting the stock options offered by startups because there’s always a bright side to everything which cannot be ignored,rather, shouldn’t be ignored I would say.

And readers, it’s not that I am blindly writing all this, if you try to do a little research, The IIT Placement Committee banned 31 startups from recruiting students from IITs. This was a step taken for the welfare of the students as such enticing job options(especially the ones involving stock options) often lead to many students landing into problematic situations without them being at fault.

There are thousands of ways through which the employers have been exploiting the contract terms, which lead to totally unexpected & mismatched outcomes for the employees. If there is no salary cut, then the stock options must be considered as icing on the cake. Because if the startup fails, the employee has nothing to loose. The salary compensation, experiences gained, and general journey should be the core value with stock options as a nice addition.


ecellblogger wrote 53 posts

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