How may stock options should you get?
When it comes to compensation nothing is harder than figuring out if your option grant was fair. It’s near impossible to know the number of options granted to your boss or peers leaving you with no basis for comparison. A friend proposed the following formula to determine the competitiness of an option grant:
Options Granted = Your base salary / option strike price
If your option grant exceeds this number, then it is a competative offer. If the grant is below this, then they are low-balling you. I would always use what you think your market-based base salary is. So if you plan to take a lower salary then use what you made at your last job or whatever you think your market value is.
Of course, compensation is always determined on many factors and no one formula is right. I do think this is a good rule of thumb to add to your compensation toolbox.
As always, I’d like to hear what you think. Is this formula useful or useless?
I think this formula is a great start. It seems that the “acceptability” of stock option grants also depends on how your actual salary relates to your market-based salary. If you’ve accepted a lower salary in exchange for more equity, then I would think a fair grant would be higher than the formula yields. If you’ve accepted a higher salary and less equity, then a fair grant would be lower than the formula yields.
So maybe something like
options granted = market salary / strike price * (market salary / actual salary)
Hmm, the formula I proposed doesn’t yield useful results for very low actual salaries (the number of options granted approaches infinity as the actual salary approaches zero).
To come up with a useful formula, it would help to know what a reasonable number of stock options is for someone who chooses pure equity as compensation.
This equation appears to be a neat way to avoid having to really think about the problem, and I would submit that anyone using this formula is lacking a true understanding of how stock options work.
1) Strike price means nothing. What does mean something is the number of outstanding stock options and the expected potential of those options. Without these two items, no value can be placed on the options granted.
2) Market salary? Again, this isn’t a reference point without knowing the number of options and the potential value these options can create. Once this is known, some sort of addition or subtraction from market salary can take place to determine an equitible compensation package that makes sense for the company and the employee.
I think a revealing test for whoever told you this would be an explanation of why this formula makes sense.
Why does strike price mean nothing? My understanding is that strike is typically the fair market value of the shares. Now, I agree the stock may not be liquid and therefore stock price is is not determined by a true market. Still, strike price represents what others think the company is worth. It’s better than nothing.
The formula basically means that your upside at the very beginning is 1 times your base salary. Does that make it a fair grant? I am not really sure.
You can always calculate the percentage of the company you would get based on your options. Simple enough and I am sure most people do it. This though begs the question as to if that percentage fair for me? How do you know?
It would be very useful if someone made all this information available anonymously so you could figure out what is fair.
The reason strike price means nothing in compensation negotiation is twofold. (Yes, it means something, but in compensation negotiation, it means nothing without the other numbers.) First, the strike price is determined as a valuation at the time of funding; consequently, if you come in 1 year after the funding, the “estimated” value of the company may be radically different. Second, you have to remember that your gain on the options is the value of the option at sale time minus the strike price.
I’m not sure how you are calculating your upside being 1X your base salary. Your upside is the potential gain of the stock option above the strike price. In other words, if the company goes public at the same price as your strike price, you get nothing; therefore, it wouldn’t matter how many division tricks were done to calculate the number of options. You are absolutely correct in that you care about your percentage of the options within the pool and the potential valuation of the company at the time the options could be sold.
Lastly, the math doesn’t really seem to pan out on this proposed method. If someone had a really large base salary, the equation might give a number that is more than the number of outstanding shares, which makes no sense. If someone bargained for a really low base salary, their options would be non-existent, which isn’t the way these things work. Most often, a person would negotiate a higher base salary if they thought the upside of the options had a low potential and a lower base salary if they thought the upside of the options had a high potential. This equation would provide just the opposite of this.
I think strike price is supposed to be fair market value. I think you are correct in that it usually only changes around funding events. Still it is the closest thing you have to market value.
You are right, your upside is not really 1 X your base. What I should have said was your stake (or basis) in the company is 1 X you base. I think this is useful as it gives you a starting point for everyone. If the stock goes up everyone benefits in relationship to their salary. Assuming salary is in line with your market value then this seems fair.
I don’t think there is any magic formula. Still there has to be more than just percent of company to compare. How do any of us know what percent we should get. What market information do we have to get to fair percentage we should get?
I do think you have to assume the salary is in line with your market value. That is subjective. Clearly a very high or low salary invalidates the formula.
What if:
1. Your actual salary is the market salary.
2. The fair number of options for you to receive is x.
3. I work at the same company, and my actual salary is zero, because I chose a pure-equity compensation package.
What should my stock allocation be?
Well, if we assume the original equation isn’t worth debating anymore (like I have :-)), you would calculate what your percentage of stock options (minus the strike price) would be worth in the case where the stock acquired a cash value and/or where you would be willing to “cash out”. If this amount was equal to or more than your market/actual salary (taking years into account), you would consider it a reasonable deal. Unfortunately, guessing the value of the stock when it has an actual liquid value is one tough nut to crack and most of the reason there isn’t a magical formula, but just like VC’s place valuations during funding, it can be estimated. Obviously, if you were an owner or looking for enough equity to have decision-making power, you might select a different reference point than market salary.
p.s. I assume we’ve been mostly talking about startups or very small companies, because most larger companies will only pay salaries within market-based ranges.