Four Steps to Assessing a Stock Option Grant

I recently assisted my wife in negotiating an offer letter for a senior level job with a late stage start-up and noticed that many individuals don’t know how to assess a stock option grant. Most offer letters just include your position, salary, incentives, and sometimes an opportunity to acquire a specific number of shares.

When you get an option grant in an offer letter, you usually get very little information. Typically, you are just given the quantity of options you will get and maybe the vesting timeline. If an option grant is part of your compensation package, you should ask the four questions below to ensure you completely understand what you are obtaining.

1. What are the vesting terms, and when does it start?

Vesting permits workers to accumulate stock over time as an incentive to remain with the firm. The vesting schedule may be included in the offer letter, but if not, you should request it. A typical vesting plan is 25% vested after the first year, followed by monthly vesting for the next three years, until you are completely vested after four years. You should also clarify that vesting will begin on your first day, rather than when the option is officially granted by the board, since this might make a significant difference if you have a “normal” vesting schedule.

2. What is the value of my option grant in terms of a percentage of the fully diluted company?

A 50,000 share option grant may seem like a lot, but if the firm has 500,000,000 shares, it is merely 0.01 percent of the corporation. Even the most basic value estimates need you to know what portion of the business your grant represents. If the corporation refuses to provide you with this information, keep in mind that it may be found in the company’s corporate filings, which are public record and are kept with the secretary of state. It would be strange if a corporation objected to providing you with this information.

3. What is the cost of your options per share?

The Board is obligated to award stock options at the stock’s current fair market value. This is often accomplished by relying on an expert evaluation known as a 409A valuation study, which is valid for a year until a substantial event occurs (i.e. another round of funding). It’s not unreasonable to request the most current 409A valuation statistics so you know how much your stock is worth on day one. With each new 409A, you may follow the value of the shares during your tenure at the firm.

4. When is the next board meeting, and will the current 409A valuation report be valid at that meeting?

Stock options are not valid unless the award is approved by the board of directors. If the 409A is about to “get stale,” the official option grant may be delayed for a long time (I’ve seen delays of over a year), and if the firm is doing well, the fair market value of the shares can rise considerably. Because this question is also an indirect method of asking if the firm expects any important developments in the near future (for example, raising money or negotiating a strategic deal), it would not be unusual for them to decline to answer it.

I’ve told clients who are worried that asking these inquiries is improper and might affect their future work opportunities. I’ve discovered that demonstrating that you’re actively reviewing the offer letter sends a favourable signal to the prospective employer. Companies seek to recruit competent staff that are clever. All of these concerns are understandable, particularly for anybody contemplating a career beyond entry or clerical level (where equity compensation is much less common). The questions are given in descending order of reasonableness, so if you get stuck after the first or second one, you may leave ship and reconsider your strategy.