Equity Or Cash Compensation? Deciding What’s More Valuable To An Employee

Lt. Governor Gavin Newsom and Mega YachtThe only way someone can truly get rich is through equity. Think about all the billionaires in the world. Almost all of their net worth comes from their equity stakes in huge businesses such as Microsoft, Google, Facebook, and Berkshire Hathaway. The only people who are going to get rich making a salary are perhaps investment bankers, hedge fund managers, strategy consultants, doctors, and big lawyers. But even those guys aren’t going to crush it with their six figure salaries unless they become partners in their respective firms or practices.

Every once in a while I go jogging along the mansions in Pacific Heights on Broadway and Lyon St in San Francisco. I specifically choose this area because it’s inspirational to see beautiful homes. All of the homes are valued between $10-$25 million dollars. And guess what? Every single one of the owners is an entrepreneur.

There’s the Getty family (Getty Oil), the Ellison family (Oracle), the Haas family (Levi’s), and the Sachs family (Yammer), to name a few of the owners who are clustered in these few blocks of extreme wealth. Even if I made a million dollars a year, I’ll still never be able to afford a $20 million dollar home. Just the property tax alone costs $220,000 a year.

Ownership is the key to building outsized wealth. And ownership is one of the main reasons why I’ve chosen to pursue entrepreneurship. It is truly a fantastic feeling to build something out of nothing and create an asset that is potentially worth a great deal. Even if someone offered $2 million for Financial Samurai, I’m not sure I’d sell my baby. Only really evil people sell babies right? Besides, the government would get half. (Related: How Much Do I Have To Make As An Entrepreneur To Replace My Day Job Income?)

CASH AND EQUITY COMPENSATION AT MY OLD JOB

When I worked in investment banking, roughly 25%-150% of your base salary comprised of a bonus (e.g. $100,000 base + $100,000 bonus). The bonus was then split up into a cash portion which was paid out to you immediately, and a stock portion that vested over three years. The higher your bonus, the higher percentage you would receive in stock.

To own stock is to be an owner of the company. When you are an owner of the company, you tend to think in ways that are more beneficial to the firm. Perhaps you’ll be more inclined to pick up the trash that someone left in the hallway. Maybe you’ll be more vociferous in defending the merits of your CEO’s actions. Or perhaps your mind will go into overdrive to think of better ways to cut costs or generate more revenue.

Many firms offer both a cash and equity compensation mix for employees who’ve demonstrated their loyalty. I was at my old firm for 11 years and amassed three years worth of deferred compensation that I would lose if I quit. Not quitting, but finding an amicable way to get laid off was key to retaining my deferred compensation as I embarked on my entrepreneurial journey. The deferred compensation plus my severance was enough to provide for six years worth of living expenses at my current rate. With such a safety net, I felt I could take my time to do what’s right instead of do something just for the sake of money.

If all I received was a pay check from work, I’m not sure if I would have given more than 100% of my effort on a constant basis. Maybe I’d feel more inclined to leave once the clock struck 5 pm, instead of stay back until 7 or 8pm to make sure all my client requests were handled. If the pay raise scale was fixed at a single percentage annual increase based on a rigid number years of service, I definitely wouldn’t have been motivated to try harder. Perhaps this is why there’s such malaise in the government or amongst folks who are in unions. (See: Are You For Or Against Labor Unions?)

CASH AND EQUITY COMPENSATION AT MY NEW JOB

I’ve decided to continue working as a consultant at Personal Capital because I’m having a lot of fun, learning a lot about the financial tech startup world, meeting new people, and feel like I’m making a difference in helping build their brand online through content. I truly believe the wealth management industry is in for a big shakeup over the next 5-10 years as technology starts being leveraged to help people get better control of their financial lives. To be a part of such change is exciting.

In an incredible show of flexibility and goodwill, Personal Capital gave me the offer of earning 100% cash compensation, a 50/50 mixture of cash and equity compensation, or 100% equity compensation in the form of options. The only time I’ve ever heard of a consultant or contractor receive equity compensation for their work is when that one artist painted a mural for Facebook years before they went public. Great move on his part!

One of the benefits of being financially independent is flexibility. I don’t need cash compensation to survive because I’ve got passive income and online income currently flowing in. A fair market compensation is all I ask. I’m pretty allergic to cash as you may have noticed in the post “Pay Down Debt Or Leverage Up?” The more cash I have, the more I’ve got to figure out what to do with it. I’d much rather invest it for 10 years, not think about the money, and hopefully let the investment compound at a 10% IRR.

Receiving options is clearly a gamble because nobody knows the future. We could be in the late stages of a tech bubble about to burst, with the $19 billion dollar Facebook acquisition of WhatsApp marking the top. Who would have thought that WhatsApp is now worth $2 billion dollars more than LinkedIn? Crazy, I say.

Or, maybe we’re still only 10% of the way through an incredible multi-decade long growth story where Personal Capital 15 years from now becomes the dominant digital wealth advisor with its smart combination of free online financial tools and financial advisory offices in 100 different cities across America.

If Personal Capital becomes a runaway success, I will attempt to kick myself in the face with an inflexible right leg if I go the 100% cash compensation route. Of course I can use the cash to invest in some other home run company, but those are hard to find, especially in the private stage.

On the other hand, if Personal Capital fails, I will have ended up spending all that time with zero monetary return. But you know what? As I wrote in my About page, money stopped being a big driver for me a long time ago. It would certainly be nice to get a financial windfall, but I’m most interested in learning new things and experiencing an interesting life. I’ve learned a tremendous amount about online marketing already. Furthermore, I’m having fun.

Given such thoughts and circumstances, going at least the combination choice of cash and equity makes sense.

HOW TO DETERMINE HOW MUCH EQUITY TO RECEIVE?

If I was the CEO of a startup, I would be impressed if a potential employee believed in my company so much as to decide on getting compensated 100% in equity options. If all my employee had was options that could not be monetized unless there was a liquidity event, I would feel comfortable knowing s/he would do everything possible and then some to help make our company a success. Interests are perfectly aligned.

At the same time, I’d probably be protective of how much equity I would give out if I believed the equity will grow by tremendous amounts. There’s only so many options I could give, unless I issued new shares and diluted myself and the existing shareholder base. Then again, I’d enjoy sharing the wealth for all those who helped make the company a success. Winning on your own feels lonely.

Given I strongly believe in Personal Capital and I don’t need more cash to pay the bills, I’ve decided to roll the dice and go for 100% equity compensation. I think Personal Capital can be a five bagger (return 500%) over the next five years if we properly execute our strategy. When it comes to larger investments, I’m always thinking long term – five years minimum, ten years preferable.

Deciding Between Options Or Cash:

1) Make an honest assessment of cash flow needs. Calculate an income level that covers all your basic needs at the very least. Living paycheck-to-paycheck is stressful and will hurt your quality of life. But, you might also be inspired to work even harder if you don’t have anything to spare.

2) How strongly do you believe in management? Does the C-level team have relevant industry experience with a long track record for successful execution? Or are they recent college graduates who just have a great idea, but no experience executing a vision? Management can be young and inexperienced, but they better have someone who’s been there and done that to guide them through the land mines.

3) How big is the market opportunity? Every startup sees a huge market opportunity, otherwise they wouldn’t launch their business in the first place. The better question is, what is the real market opportunity? Overestimating the potential customer base is an egregious error that will severely affect the business model.

4) How much income and net worth is enough to make you feel satisfied? I understand it’s hard to know until you get there, but you’ve got to make some assumptions.

5) Do the Venture Capitalists have some preferential clause? In case of a liquidity event, some VCs stipulate a 2X or greater minimum return before shareholders get paid. For example, let’s say a VC invests $10 million for a 10% stake with a guaranteed 2X minimum return, valuing the company at $100 million. The company sells for $200 million. The VC’s stake leaves only $160 million to be divided by the remaining shareholders – a 60% return instead of a 100% return for employees.

6) What is the cliff and vesting schedule? A one year cliff and four year vest means that you must work at the company for one year before getting your first year’s options. If you get fired or leave a day before the one year cliff, you get nothing. With a four year vesting schedule, your 40,000 options are granted over four years at 10,000 a year. Most companies vest every month after the initial one year cliff.

7) How many shares outstanding are there? 40,000 shares sounds nice, but if there are 1 billion shares outstanding, 40,000 is just 0.00004%. How much equity you receive depends upon how early you start at the company and your negotiations skills.

8) What is the current value of each option worth? There are a couple values to consider. The value as reported to the IRS for regulatory purposes and the value management believes the company is worth to outside investors.

9) What happens to your options if your company gets acquired? Let’s say you’re one year in and the company gets acquired. Do your options immediately vest, or do you lose the remaining three years of a four year vest? Everything is negotiable. If the acquiring company wants you to stay they’ll do whatever it takes to make you whole or perhaps give you more incentive to stay.

10) What is the ultimate monetary goal of the company? Is senior management planning on selling to a bigger fish while public, or going IPO? Figure out what the grand vision is by speaking to management and the time frame they think it will take to get there.

Treat equity options compensation as money you’re willing to lose. If you don’t have a choice, then treat your options as simply funny money that has no value except for when it does. Don’t ever assume your options will be worth something, and certainly don’t ever spend money that you haven’t yet received.

THERE ARE NO GUARANTEES

Choosing between cash and equity is a personal decision based on your individual cash flow needs. Ownership is one of the best ways to create wealth and I’m excited to not only be an owner in a new company, but an owner who has the ability to help create more value.

Related Post: Stock Options Or RSUs? An Equity Options Primer

Readers, have you ever had to decide between cash or equity option compensation? If so, how did you choose? If you felt with supreme confidence the company you worked for would eventually become a huge success, wouldn’t you be willing to go all-in with options? Please share some of the pitfalls of owning options if you can.

Note: The PC marketing team is looking to hire people in analytics, acquisition, PR, branding, and content if anybody is looking for a job at a growing financial tech company in SF. Shoot me an e-mail with an intro and resume and I’ll pass it along. 

Photo: Lt. Governor Gavin Newsom texting on his phone in front of Larry Ellison’s Mega Yacht, 2014, FS.

Regards,

Sam

Sam started Financial Samurai in 2009 during the depths of the financial crisis as a way to make sense of chaos. After 13 years working on Wall Street, Sam decided to retire in 2012 to utilize everything he learned in business school to focus on online entrepreneurship.

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Comments

  1. nbsdmp says

    Let me be one of the first ones to say this: good freaking move!

    The whole article is great and makes some really good points. My parents literally told me I was making a huge mistake when I left the mothership big company for an equity opportunity. 100% hands down best decision ever. Yep, differed compensation is a risk Sam, but you are doing exactly what I plan to do when I move to the next phase…probably a little different though because I’m an operator so I would probably be acquisitive and look for 10x opportunities that I “know” I can turn around because of all the low hanging fruit.

    Anyway hats off to you and good luck with your decision…regardless if it is a huge windfall you are doing the right thing!

  2. Bob says

    most of the time the equity share position is going to be a big fail. in most scenarios it won’t be a grand slam that people are expecting.

  3. Dave says

    Agree with Bob. Typically, equity positions in pre-IPO companies are going to be a big fail. The successes that I have experienced were from equity positions (working for the company) with already public companies that continued to thrive after going public – my pre-IPO experiences were all big fails. I would have gone with a 50/50 split between cash & equity. At least you then get some cash out of the business for you to invest however you desire – just because you don’t need the cash doesn’t mean you shouldn’t take some out for your hard work.

    • nbsdmp says

      I think Bob and Dave need to look at it through a different set of glasses. The money you would take as a salary even if you split it 50/50 would not change your lifestyle one bit because you are not doing it for the money right now, it is for the experience. I am super happy their are people who are either not willing to or have not put themselves in a position to be able to take risks…it lets those of us who are reap the rewards : ) …then we get ridiculed because you drive a fancy car/pay, wear a nice watch, date the hot women, and pay too little taxes!

      • Dave says

        I have taken the risk in more than one pre-IPO technology startup so I do speak from some experience. Yes, agree that Sam can gain the experience and that the extra cash wouldn’t change his lifestyle. However, the point was not about the experience or lifestyle, it was about diversifying his risk associated with working entirely for equity that, historically speaking, has a low probability of being a 10 bagger.

        • says

          I feel like I’m having a really good time and learning a lot. I feel fortunate to be in this position, and what I’ll lose is my time vs. losing my money if I were to make an investment. But my time is spent having fun and learning about online marketing too, so in a way, I wouldn’t mind as much. It’s really the experience and the journey which propels me to try new things.

    • says

      I realize most companies fail, and that’s just the risk I’m going to have to take. Personal Capital is beyond the “no survival” stage due to its business model, growth, and VC interest. The only way I can invest in the company is this way, as any public offerings will probably only be available for VCs or very high net worth individuals who can help the company grow in their own way.

      Please share more about your pre-IPO startup experience. Where you ever faced with the choice of cash and equity split, or was it a set figure that you were to take or leave?

      Did your companies just go bankrupt with the options ending up being worthless? It’s all about risk reward. I’m not sure I would have gone 100% equity if PC was a 6 month old startup. Probably 50/50. But PC has been around for 3.5 years and just crossed the $500 million AUM mark.

  4. Ravi says

    I’m not in the startup space, where equity can easily make up the majority of your compensation, but I do feel equity is a good way to give an incentive to people to work hard, and more importantly, to weed out people who don’t really believe in the company’s vision and ability to execute.

    Obviously, this conflicts with one’s own station in life as well. Early in your career, you don’t have much in the way of savings, but can also afford to take more risk for the upside. Later in a career, you have more assets and more cushion, but also depending on your/family’s needs you may require a certain level of cash flow.

    You’re absolutely right though, it’s nearly impossible to become truly wealthy when working for someone else unless you took a big equity portion in the company. Even Lloyd Blankfein is only worth a few hundred million $$ (yeah, I know, that’s a lot!!), but nothing in comparison to the billion dollar fortunes amassed by many IPOs in the past 5 years.

  5. says

    Sounds like a good move. You’re right it is a personal decision and in your position, where you have enough cash coming in to cover your expenses, why not roll the dice with a company that you have a hand in helping succeed? Wishing you all the best.

  6. says

    I have contemplated this myself over the last couple of years. Being in the software and finance space, I have plenty of options to go work for equity and cash.

    However, I have decided that I won’t work for equity unless I have a say or vote in the direction of the company.

    Just my 2 cents and a simple rule for me to follow when recruiters call.

    • says

      Unless you’re a C-level executive, or a huge early investor, I’m not sure anybody would have much say. But, we are all shareholders who can provide our 2 cents in meetings, as I have done w/ the CEO before.

      • says

        So as long as you get platform, I think it is ok.

        As others have expressed, this is just another investment and you have to set your personal expectations to match the risk associated with your investment into the firm.

  7. says

    My first job in my career was at a startup that offered stock as part of the compensation plan. 3 months after I started they closed the doors because they ran out of money. I’d be wary of taking equity as a significant part of my pay unless, as Brian said above, I had a significant say in the direction and operation of the company. Or if I was financially independent and working for fun anyway. Of course, getting fabulously wealthy isn’t really a goal for me. If the opportunity arose I wouldn’t turn it down, but I’d be fine with just being “well off”.

    • says

      Ouch, 3 months later? When you joined, were the signs not apparent?

      Perhaps I should write another post about how to evaluate startups before one joins.

      Nothing is a guarantee obviously, but with the grow in assets under management by PC and the interest level by VCs, I don’t think I’m taking that much of a risk. I’m going quarter by quarter anyway, not all year.

  8. says

    I would love to work for a start up! If I could do it after I retire in 2-3 years, I could easily take very little in cash and bet all of it in equity. It would have to be a big bet to make it worthwhile, perhaps Googlicious big! After all it would be my last chance to hit the jackpot.

    • says

      Gotta dream big right? Dreaming big is such a good motivator to get out of one’s comfort zone. We are going to regret more the things we don’t do than the things we end up doing.

  9. ktaylor says

    The choice, for me, between stock options and cash would also depend on the dollar value of options granted for each dollar of cash foregone. What was the ratio in your case, Sam? Some companies I’ve heard in the past grant options at 4x the equivalent cash. E.g. give up $10k in cash for $40k in total value of options (based on strike price/current market value).

    • says

      Good question. Let me ask you a question first though:

      What is a good multiple/ratio? The way I see it, there’s no free lunch. There’s a fair value to everything.

      • ktaylor says

        Cop out answer — “It depends.” I can tell you what it depends on:
        Stage of company (series A, B?)
        -Current valuation?
        -Profitable?
        -Exit Options (IPO, acquisition?)
        -Estimated growth over next 5 yrs.
        -Ownership %

          • ktaylor says

            In my situation I took the comp split (between cash and options) that was offered and didn’t negotiate to trade cash for options. In hindsight I would have traded some cash for options (maybe my first year bonus) because we had a liquidity event at a greater price than my strike. We were past series A and profitable when I came on board. Next time I’ll take on a bit more risk and take more equity vs. cash if it’s an option (no pun intended).

            • says

              Sounds good to me. At Series C level, the risk of my options being worthless is lower than Series A, but obviously the returns are lower too.

              I think the multiple you are asking is around 1.5. How does that sound?

  10. says

    Fascinating. I’ve never had an opportunity to get options from a startup so this is all new to me. There sure are a lot of things to research and consider with the company’s specific terms. Sounds like you really did your research and thought this through. Congrats sounds awesome!

  11. Josh says

    For a financially independent person such as yourself, especially consulting on a part time basis, equity compensation is the right way to go if you don’t need the extra income. Just curious, if you ever get married, would you ask your fiancee to sign a pre-nup? Unless one can find a financial equal, which doesn’t typically occur for truly financially well off single guys in their 30s, or unless the guy knew the girl before he had any money, I’m curious what your thought would be in those types of situation. Maybe you can write about it for a future topic.

    • says

      Clearly, I would simply find a financially independent woman for herself who doesn’t need the money, just the love.

      Also, there’s this thing called “automatic prenup” that I’m not sure people are aware of. Whatever you created on your own before the marriage stays with you. Whatever you create after marriage get’s split. I think that’s very fair and the way things should be.

  12. says

    Here’s another item to add to your list of important considerations when you’re evaluating a stock option grant:

    What happens to the options if you stop working for the company?

    Most VC-backed companies will grant options to employees and contractors (so ISOs and NSOs, respectively) that give you 90 days to exercise vested options after you leave the company. If you don’t exercise within that time period, you forfeit all of the equity you have earned.

    This is important to consider, because depending on the exercise price of your options, exercising may cost you a considerable chunk of change; but if you leave without exercising, then you are forfeiting all of your equity compensation and all future potential upside.

    This is less relevant when a company is very young (seed stage or Series A) and options have a very low strike price, but it becomes increasingly important as the company grows. Very few people consider this upfront, and it ends up being a mistake for many folks. Imagine the LinkedIn and Facebook employees that left over the years without exercising their options because it seemed too expensive at the time…

    • says

      At this stage, I would always exercise and pay any taxes that is associated with the process.

      Why would anybody not exercise and give up their shares? Lack of cash or negative belief in the company?

      • says

        This probably doesn’t apply to your situation, but yes, in general I see a lot of people who don’t exercise their options for both of those reasons. There are a lot of Silicon Valley employees out there that work for below market rate salaries for years due to the promise of equity upside, and then when they leave their company (often for another startup) they don’t have the cash to exercise their options, or the company isn’t doing well (most VC-backed startups fail). Then the cycle repeats with the next employer, and 10 years later the individual has been working for low pay for a decade and doesn’t own any equity. I unfortunately see this cycle frequently.

        My point is just that people need to plan ahead for what they will do with their options if they leave their employer. Many people assume they have the options “forever” regardless of what happens, when that is almost never the case.

  13. Austin says

    You’re in the perfect position to make such a move. Makes perfect sense. This is one of those inspiring gems that keep me on board here. I think I might just quit my job and raise a fund to purchase cash flowing web properties.

    • says

      It’s not a bad idea. Web properties are undervalued IMO and are huge cash generators.

      I will never sell my properties for what I’ve seen many of my peers sell for. Multiples are just way too low.

  14. Paul Dabuco says

    Equity Compensation. If a company cares “enough” to its employees and is seriously focusing on long-term win-win situation, then EquiComp is the best option.

    It is undeniably better to get your colleagues involved in the business: performance and drive dramatically increases. You win, they win!

  15. says

    I like Personal Capital quite a bit– all the signs from my perspective point to it working out very well. I think equity compensation makes a lot of sense– swing for the fences and I hope it works out well for you!

  16. Maverick says

    Spouse has an ESOP in her former employer private company. It has gone 11X since she has owned the shares originally. Has beaten S&P 500 immensely also since the ESOP began. Our concern is that the company could issue more shares at any time and dilute current share value. For now, we plan to continue to hold as there is no direct stock market correlation. Less than 5% of our total portfolio.

  17. says

    “I’m not sure I’d sell my baby. Only really evil people sell babies right?” <Love this

    You put up some great points to consider the options. I think age is also something to consider. I don't have the option but I do recall a conversation I had with someone about similar circumstances. He was paid a salary plus a bonus annually. Instead of cash he always took stake within the company. I didn't dig into it much but I was awefully curious why he hadn't made any adjustments over his years there. He was very close to retiring and the cash seemed as though it would have been a safer option.

  18. says

    Great framework for evaluating equity compensation.

    One additional point for consideration is selling vested shares before an IPO. Private companies often have a right of first refusal for any vested options. So if you want to sell to another either a known entity or via Second Market or some other intermediary, you have to offer the shares to the company first. Typically you want to maximize your sale price, but that can be difficult in a limited market such as if they try to restrict you from selling on SecondMarket. Best to know your options (so to speak) before you reach that point.

    Financial independence is the goal. Your options open up dramatically when paying your monthly bills is no longer a concern.

  19. Ace says

    Sam,

    You appear to be in an excellent financial position, so why not take equity in a firm you believe in. And pre-IPO is high risk. But post IPO Web 2.0 companies are also high risk.

    And you are very correct….. People get extremely wealthy by owning a very successful business. I’m pro diversification as far as uncorrelated assets are concerned, but when it comes to equity, I think people miss the power of concentrated investments in carefully selected companies.

    That said…… I’m not saying everyone should run out and buy out all the “Twitter” stock or what ever Web 2.0 company. If you are going to do concentration type investments, you had better do serious homework on the firm. I can pretty much forecast that GE will be here 20 years from now; I’m not so sure about any of these Web 2.0 companies.

    So…. I’ll borrow from Warren Buffett; buy a few companies with big moats around them.

  20. says

    Hey Sam,

    Awesome to hear that you run in a millionaires neighborhood and yes you are right entrepreneurship is the way to becoming rich..

    What are your thoughts on looking to do this “safely” is with calculated risk rather than take the plunge, is it do-able?

    I know this is a bit off topic but you had me thinking :)

    • says

      Hi Jeff,

      It’s a personal decision on how much risk we should take. Because I recently had some CDs expire, my liquidity situation is too high right now and I want to be investing my money instead of earning more cash.

      I see receiving equity in PC as a way of investing in a private company where I otherwise would never have the chance. I’m like a late-stage private equity investor who gets to do his part in making the company as big a success as possible. I think that’s fun and shows how much I believe in the company.

      Best of luck to you!

      Sam

  21. says

    That is the major advantage to reaching F/I, being able to take risks that you couldn’t do before. That is one of my major motivations for reaching F/I. Work instead of being a means to cover living expenses becomes a means of personal fulfillment and an opportunity to pursue unique opportunities, like yours with Personal Capital, for a possibility at a huge payoff down the road.

  22. says

    Hi FS, congrats on your success as a consultant working for such a great company. Stock Options are a tricky subject — one that I’m by no means and expert in, but one that I’ve spent a lot of time analyzing as both a consultant and full-time startup employee in multiple early-stage companies.

    Here’s some things to think about…

    1) As a consultant, your shares should not have a vesting schedule, but instead be offered monthly in lieu of (or as part of) pay. Once your shares vest each month, you should be able to buy the shares. Having a cliff as a month-to-month consultant doesn’t make sense.

    2) What is the real value of those shares today? Sure, the investors may say that they are worth $2 a share (example) but what does that mean? It is in the best interest of the investors and board to make the shares look very attractive to employees. How can they do this? There are many tricks that these companies have up their sleeves. A common trick is to split the stock so there are many more shares. This doesn’t actually change the value, but it enables the business to give out “more” shares to new employees even though they are in total worth the same as a smaller amount before the split. As long as you know what the shares are worth and the total outstanding shares, you can make a fair judgement call on the situation.

    3) Even if you’re granted shares that are supposedly = to the cash value you would be paid (i.e. $5000 / mo in options vs cash) you aren’t actually getting the stock. You have the right to BUY the stock for $5000 each month.

    4) As a FT employee you might not even be able to buy it right away, but as a consultant with no vesting schedule you should be able to. If you don’t then depending on the rules after 90 days you stop working for the company you could lose your right to exercise those options. That means poof all of your earnings are gone.

    5) So are they paying you in stock options or stock? If they’re paying you in stock, that’s a different story. Still, pay close attention to taxes. They can really bite you in the ass.

    6) When you exercise options you have to pay the difference between the strike price (what they were worth when you got them) and the price they are worth when you exercise them. Of course this price is meaningless because you can’t actually sell the stock. This is what really sucks for employees. For example an employee could have a strike price of $1. The company could raise more funds and have a valuation that brings the shares up to $2 per common share. The employee has put in many years of service at the firm and decides for his career he must leave. He has 90 days to buy those options and he must pay taxes on the $1 difference per share he exercises. That’s not so bad if the shares are worth $10 each in the long run, but more often then not the company cannot maintain its growth and suddenly the shares are going backwards in price. It will take many, many years to know if they will be worth anything or if you will have to take a loss on the shares entirely. Even if you had a very low strike price (i.e. came in Series A round or pre-A) that is still based on some made up valuation but some guys on Sand Hill Road who are running numbers in their favor. The CEO/founder has some clout in negotiating terms that benefit him if the company starts to turn sour, but I’ve never heard of a CEO negotiating terms that help his employees. This is not necessarily a bad thing — if the employees feel too safe why would they work to make the company so successful (i.e. long hours that a startup requires.) That said, few realize how the CEO can walk away with millions of dollars even if the company is run into the ground and the common employee has lost money on exercising their options. Funny how that works.

    7) This is not to say that stock options are terrible in all cases. Clearly there are companies that do well and where early employees end up being able to afford a house in the nicer areas of Silicon Valley — not the finest neighborhoods of SF mind you, but at least an entry-level house in Palo Alto or a reasonable ($1.5M-$2M) condo in the city. It’s really lottery-ticket-level-stats if you think your options will get you into a $20M house — but it’s always nice to dream.

    8) What I’ve learned — most importantly — is determine if the company you are working for (and getting stock options at) has a fundamental business model that makes sense. Are customers willing to pay for the product? If it’s a recurring revenue business model, are the customers renewing (or if it’s too early to see renewals, do you honestly believe that the founding team and product team understand their market enough and care enough to make the right calls in order to drive long-term customer satisfaction?) This formula doesn’t work for every business (clearly an Instagram being picked up for $1B by Facebook wouldn’t fit the formula) but in most cases as an intelligent individual you can ask yourself — 1) is this company able to get customers, 2) is this company able to keep customers, and 3) is this company able to grow their products/offerings enough to get customers to buy more? If you think your company is an acquisition target… are there enough big businesses out there who would care about the company and its offerings? If an IPO is the target then that’s often a very long journey and it takes a team that really is in it for the long run instead of a quick flip. Here you have to look at the motives of the founders — are they already wealthy? Do they want to prove they can do it again? Do they want to build a public company after a series of successful acquisitions? Look at who is running the company and why and you will have your answer. This will tell you a lot about the real value of the options.

    9) Even then there are a whole host of other ways to screw employees out of whatever they think their options are worth. Most of the time an acquisition isn’t a true success and employees can not have access to the fruits of their labor. Executives have clauses written into their contracts protecting them but the common employee or consultant does not.

    10) I firmly believe it’s better to earn shares as a consultant in a business than as an employee. Why? You an earn them monthly with no vesting (vesting is what I think of as pyrite handcuffs) and if the company starts to tank you can leave without it being a big ordeal. What’s more you can DIVERSIFY across multiple startups… which maybe isn’t the best if you happen to miss working for one startup that will IPO for 10 years straight, but diversification is a way better strategy to hit the options jackpot. Plus, if you are consulting for a company that really seems to have its shit together you can make the call to work their full time once you’ve dipped your toes in the water.

    The PC team is top notch and they are definitely on to something, so options in lieu of cash if you can afford it might not be a terrible idea. Sometimes you just have to take a risk.

    However, remember that when you exercise your shares you are buying stock. What I didn’t think clearly about was how in a previous company I was putting over $15,000 into one super small cap high risk stock that was illiquid and locked into that stock for many years to come. Meanwhile I flinched when I purchased $15,000 in Apple stock at $150 a share because THAT felt risky. Buying stock in the company I was working at for “cheap” felt like part of my compensation – a privilege and I’d be a fool not to buy the shares for so low (even though I was on a vesting schedule… that’s a whole other story.) If I was already a millionaire, $15,000 would not be that much to risk. But at the time with $125k or so in networth, $15k (plus the loan I had to take from the company in order to early exercise) was a huge chunk of my total portfolio. Yes, it could have worked out where I made a lot of money off of this risk, but one could also put 10% of their portfolio into any other high-risk stock AND also have the option to trade out of it if the company starts to bomb. In this case you’re stuck. That’s what I think people don’t fully understand, and why it’s really unfortunate that companies trick employees into thinking stock options are so great. They can be — but really they are 9 times out of 10 decent for the executive team and crappy for everyone else, even in a “successful” outcome.

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