Question: I have a new employment offer from a young private company or PE firm’s portfolio company. How do I evaluate the stock options that are part of the offer?
As Executive Compensation attorneys, our clients ask this question frequently. So I have a lot of tips on how to evaluate your offer. Some of these answers are found in the option award agreement, the equity plan or shareholder/operating agreement, but some can only be answered by discussion with the principal investors, such as the company founder or the private equity (PE) or Venture Capital (VC) investor.
1. How much is the stock currently worth?
Your exercise price should be no less than the fair market value of the underlying stock. Did they have a recent independent appraisal (sometimes called a “409A valuation”)? Or a recent round of financing which gave them a valuation? Another way to ask this: how does my strike price compare to the purchase price of the VC or PE company's investment? Sometimes its the same as their investment price, but it actually should be much lower, because the common stock your option covers is worth far less than the VC's preferred stock.
2. What is the vesting schedule?
Do the options vest on termination without Cause? What happens on Change in Control? Is there any performance hurdle to achieve change in control vesting? Often, there is a substantial financial hurdle before many of the options participate in the exit event.
3. What percentage of the Company is represented by my option grant?
Are there upcoming rounds of financing that will dilute you? The total pool of options for management can be 10 to 20% of the total available equity. Even if your offer includes a large portion of that pool, your offer has these vulnerabilities: (i) the next round of financing will dilute your interest, or (ii) the performance-hurdle before your option participates in a liquidity event (exit event) is so high, you won't ever achieve your promised percentage of ownership. Some of these things will be outside of your control. But at least, you should know what will be happening next with the financing of the employer before you accept the offer.
4. What is the exit strategy of the Company?
Is the Company being prepped for a sale? In the case of a sale, will the buyer need to keep you in your role? Some jobs are more vulnerable to post-change in control termination than others. Does your offer include enough change in control protection if you are fired?
5. What if I have to leave employment before the Exit? Can I keep my options?
After employment, when do the vested options expire? The post-employment expiration date for options is negotiable. If you have a family event and need to relocate or quit before the big exit, even though your options are vested, you could lose all the growth that resulted from your hard work. The end result is negotiable but its better to settle these details upfront so that you do not have to live with the 90-day expiration that is found in many awards.
6. What if there is no exit in 7 or 10 years?
Is there any way to get liquidity on my options, like a Company buy-back? (often the answer is "no", but we find that this is open to negotiation. And, asking this question opens the door to a conversation about cash liquidity, cash compensation enhancement, net exercise processes to cover taxes).
7. If the value of the portfolio company is very low, would restricted stock (and 83(b) election) be better for tax purposes than stock options?
You may need an executive compensation attorney or tax professional to help you figure this out.
These seven questions give you a starting place to evaluate the stock options in your employment offer.
Sandra Cohen, Esq is an executive compensation attorney who writes and speaks regularly on the topic of equity plans.