How To Value Your Stock Options
Valuing stock options or comparing equity offers doesn’t have to be a complete guessing game. I’ve built a simple tool that I found to be very useful for coming up with the expected value, linked at the end of this article, and which I’ll explain further below.
At my past two tech companies (Square & Docker) I have been in charge of educating new hires and candidates what their equity may potentially be worth someday.
Before we start, you need to ask for a couple pieces of information from the companies you are evaluating. If you’ve been given an offer, the company should also be able to provide you with the following numbers.
1. Current 409A price
The 409A is an obscure IRS code which basically means every private company has to have an independent value for its common shares. This is that value and also is the price you pay to exercise your shares.
2. Latest Preferred Price
The latest preferred price is the price per share paid by investors at the last preferred round (Series A, B, C, D, etc).
3. Company Valuation
The valuation is what the company is now “worth” based on the last funding round. A “unicorn” is said to have a $1 Billion valuation. For further information on valuation check out my past article here.
Fully Diluted Shares is the last piece of information you will need. This is all of the shares of the company added together (preferred, common, options, and option pool). This can be backed into by taking the valuation above (eg. $1B) divided by the preferred price per share (eg. $25). You will need either the valuation or the fully diluted shares for your calculation.
Let’s look at an example of two startups at different stages, Startup X and Startup Y:
Let’s assume both are great companies and you get the following offers:
“Startup X is giving me more options, I should go with them! Wait, Startup Y is giving me a higher percentage of the company, I should go with them!” I hear these arguments all the time. What actually matters is not the higher numbers or percentages, but what the FUTURE value is in real MONEY. 🤑
I like to use a method which takes into account the difference between the future stock price (whatever you expect it may be) and the exercise price. Add in a dilution percentage and you are on your way!
Stick with me, its actually fairly simple math.
The table below shows different exit values for Startup X and what proceeds you would expect to make at each exit value based on your offer. You do have to peer into your crystal ball and come up with what realistically this company might be worth in the future (this is where your assumptions come into play — do your due diligence!).
If you think Startup X at a $1B valuation is just getting started and could be worth $3B by the time it exits, you can expect to make around $1.1 Million. Pretty good outcome! However, if the company doesn’t grow and exits at the same value as the last round of financing, $1B, then you would yield around $255K. This model assumes 15% dilution, which takes into account a few additional rounds of financing at approximately 5% each.
Now let’s compare this to Startup Y, which if you recall is currently valued at $100M but looks very promising. If you look at the table below it would have to grow significantly to a $1.2B valuation (12 times its current valuation) for you to get a $1 Million payout. This is mostly due to your offer being only 10,000 options versus 20,000 with Startup X. This model also assumes 15% dilution, but keep in mind dilution generally will be more for earlier stage startups as they will raise more rounds of funding before going public or being acquired.
Once you have these few pieces of information (which you should always ask for!) you too can create the tables above and run some numbers. This has definitely helped me compare offers and negotiate for more options. For example, let’s say you’re comparing at what point the payoff from your options will reach that $1M payout. Using this tool, Startup X needs to triple its valuation to $3B and Startup Y needs to grow to 12 times its current valuation to $1.2B. I’d probably negotiate additional options before considering the Startup Y offer.
If you’d like to download the above tables with formulas, you can download the Google Doc for free HERE.
If you are trying to value Restricted Stock Units (RSUs), it’s actually an easier calculation as the RSU would just be worth whatever the price per share you expect at exit multiplied by your number of RSUs. So you can use the model but put $0 as the exercise price. You typically will receive fewer RSUs than options since they have no exercise price to pay.
Now the tools are in your hands. I encourage you to play around with the spreadsheet and tailor the exit prices to what you feel is realistic.
Best of luck in finding a future decacorn! 🦄🦄🦄🦄🦄🦄🦄🦄🦄🦄
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