Do we understand our startup equity options?
1 in 4 people with startup equity options might be in for a nasty surprise.
Equity options are now a common feature of startup life — but are employees getting a good deal? After hearing of and experiencing a couple of horror stories over the last few years I decided to gather some data on the state of options schemes across different companies.
Options are meant to achieve a couple of things. They should compensate startup teams for the decreased job security, workplace quality and sometimes salary that startup life entails — and on a more general level, aligning employee interests with those of the company owners is designed to reduce the principle-agent problem that a separation of ownership and control can entail.
If the potential upside of options are your thing (and they aren’t for some people — that’s a different conversation), then it should matter to you that your options are real, legally binding and likely to actually exercise in a liquidity event. Vague promises aren’t going to cut it once the lawyers get involved.
The survey was 10 questions long - mainly because that’s what you get on SurveyMonkey’s free tier, but this seemed like a nice constraint to keep things simple. I publicised via Twitter and the LRUG mailing list. A designer friend also posted it to Designer News, and I posted to reddit — I don’t use reddit, so I’m pretty sure it was buried instantly after I chose the wrong subreddit.
The idea was to understand the overall ‘quality’ of the options that were being offered, and then to see if it was possible to observe any trends/differences by geography, experience or when in the employment lifecycle they were offered. I was explicit in only asking for responses from people who were (or had been) part of a company option scheme, and I didn’t probe at all on whether people considered the schemes a good idea in general - that’s a different debate.
I was delighted to receive 128 responses over four days. Definitely not a big enough sample size to draw any scientific conclusions (although face cream is sold on less), but enough to suggest a few general trends.
Roughly 50% (66) of responses were from the UK (to be expected as I’m based in the UK and I publicised to UK people), 27% (34) were from the US. Canada, Germany and Israel made up the remainder. Again, not really enough data to prove any differences between US vs UK, but maybe a hint at something larger.
I didn’t reveal my hypotheses in advance, but they were:
- Implementation of options schemes is inconsistent across companies, with a sizeable chunk of people without the proper paperwork or understanding of what their options are
- By geography, UK startups and UK employees were generally less au fait with options schemes than their US counterparts, and that the quality of implementation is lower in the UK
- Those who had achieved success with equity options in the past would be more comfortable with entering schemes again, and would insist on better quality implementations
How Savvy Are We?
To assess how familiar people were with options, I asked:
Have you had a successful return in the past from an option scheme?
- Yes: 18.75% (24)
- No: 81.25% (104)
Almost 20% had achieved a successful exit before. I suspect that this number will be higher than the startup community as a whole — Nesta’s Siding With Angels suggests that 80% of cash returned from angel investments came from 9% of exits. As this survey explicitly only asked for responses from people who’d had a successful exit in the future, it appears that this group over-indexes on success: i.e., if you’ve had a successful return before, you’re more likely to get involved with options again.
Secondly, I gave a list of option-related terms and asked people to assess their familiarity with them:
- Option: 94.49% (120)
- Grant: 51.18% (65)
- Exercise: 72.44% (92)
- Vest: 80.31% (102)
- Share: 87.40% (111)
- Strike price: 56.69% (72)
- Dilution: 70.08% (89)
As a reminder, the lifecycle of options goes something like this:
- You are granted options on a grant date in an option agreement, which needs to be signed and dated. These options have a strike price — the price at which the options entitle you to by shares/stock.
- These options vest over a vesting schedule; maybe monthly or quarterly and typically over four years.
- Often there is a one year cliff in the schedule — after a year, 25% of your options will vest, and after that they’ll vest in more regular, smaller chunks.
- If a liquidity event occurs (typically an IPO or a sale and not from additional investment), then you can exercise those options that have vested as part of the event.
How much will you make if there’s a sale? This will depend on the valuation. Say your company is valued at £200m, there are 10million options and shares issued and you have 10,000 of them priced with a strike price of £0.50 each. When a sale happens, each share has a price of £20 and you have the option to buy 10,000 of them for £0.50, meaning you have a profit of £19.50 per option, multiplied by the 10,000 shares you buy and you’re up £195,000. Not bad… even after the taxman has had his share.
On the technical terminology, it seems that Grant and Strike Price are the least understood technical terms at around 50% familiarity, followed by Exercise and Vest at 72% and 80% respectively. Overall, though, the majority of people understand the technical bits of how options work. It makes sense that this isn’t 100% — a lot of us ignore the details of our options until a liquidity event is at hand — until then, they’re just fantasy money.
A note — I didn’t ask about accelerated vesting, whereby all of your options will vest if a liquidity event occurs. I’d argue this is something you want to push hard for in your agreement.
The American Dream
Familiarity with terminology was higher for US respondents.
Strike Price was understood by 71% (versus 57% overall), and Grant was at 62%, up 11 points on the overall case. Success from options schemes in the past was lower for US respondents compared to the overall case — 12% down from 19% overall — suggesting that US respondents are more familiar with options schemes and comfortable participating in them, even though fewer people have had a successful return before.
Do We Have Good Quality Options?
You need a signed agreement.
We can assume that, if you’re in an options scheme, you want things to work smoothly if a liquidity event happens. It’s important to have an option agreement in place that lists the vesting schedule and the strike price for your options. Do people have this?
In a survey only for people who were part of an options scheme, 76.24% (77) said they had an signed agreement for the options. Yes, it’s the majority, but this still means that 13.86% (14) have no agreement at all, and 9.90% (10) ‘sort of’ have an agreement. I added this final option because I expected a grey area, and the comments supported this:
Eventually. The CEO was dragging his feet for over a year before anyone got the proper paperwork
I’ve had several agreements. My most recent one is still not signed.
I have email documentation from the founder which states how many shares I have with his email signature attached, which also reflects the same info from the paper documentation. Except the paper documents are not signed by him.
My contract states that I have X shares awarded to me on joining but I haven’t got the paperwork about strike price etc.
It’s tough to estimate how many of the ‘sort ofs’ have an agreement, and sometimes there are legitimate reasons that paperwork can be delayed — for example in the UK, the common EMI scheme requires a valuation from HMRC and these expire and have to be re-calculated.
Even so, almost a quarter of respondents don’t have an options agreement that they can rely upon.
You need to know the details of your options.
How many options you have, how they vest and what the strike price is are all essential pieces of information. Yet, just as with having a signed agreement, many respondents said they haven’t been told these details.
When asked if they were aware of the number of options held and their vesting schedule, 88% clicked “Yes (even if you can’t remember exactly, but have a signed agreement)”, and 12% clicked “I have not been told”. Curiously, the percentage of people who felt they knew these details was lower than the proportion who had a signed agreement.
Breaking down the numbers of those who have a signed agreement, two respondents hadn’t been told their vesting schedule or number of options — suggesting that those signed agreements are lacking in some crucial details.
Staggeringly, of those who didn’t have a signed agreement, more than half felt that they did have details of their options and vesting schedule (57% vs 43%):
And when asked how confident those without an signed agreement were that the company would follow through on the commitments made to them, over half (54%) felt either “very confident” or “confident” that they would.
Without an understanding of your options, their number and the vesting schedule, I’d suggest that the chances of a successful return from a liquidity event are pretty low. Yet, 12% of respondents haven’t been told crucial details of their package, and even when a signed agreement doesn’t exist, over half of respondents believed they did know their vesting schedule.
If we define quality of options as:
- having a signed options agreement, and
- knowing the vesting schedule of your options
… then I’d humbly suggest that for some of these people, they are getting a pretty raw deal. The good news, though, is that these employers are in the minority.
Polite British People
Broken down by geography (although the numbers do get quite small), US respondents’ better understanding of options schemes manifests into a greater percentage having a signed agreement and an understanding of their options and vesting schedule. 86% had a signed agreement (compared to 75% for the UK), and 93% had the schedule, compared to 84%.
This supports my initial idea that US schemes were both better understood and also better implemented, with a much higher ‘quality rating’ on the left side of the pond.
I attribute this to the US, and the Bay in particular, having a more mature startup ecosystem where well-implemented options schemes are the norm.
I’d also suggest that, culturally, a UK worker is more cynical and happier with a salary and, as a consequence, we don’t negotiate as hard in this area when joining a new company.
When Should We Push For Options?
When asked when options were offered, the vast majority (74%) were as part of an original job offer:
… with 8% receiving them within a month or so of joining, and 18% receiving after a year. This makes sense — it’s easier to negotiate when you’re joining a company — and it’s also the best time to get good quality options, too. Of those who received their options after a year, only 67% had a signed agreement (vs 79% for those who had their options as part of their offer), and only 72% knew their vesting schedule, vs 92%.
When your options come as part of your initial job offer you have the best chance of getting good quality implementation of the scheme. If you get your options later, which is unlikely, it seems that you will find it harder to get a signed agreement and a vesting schedule.
What Are Our Options Worth?
The response to question seven was intriguing.
Were you made aware of the valuation of your options when you were offered them?
Two thirds (66.33%) of respondents had been given a valuation of their options at the time of offer. The question is: how? Until the market has decided on the value of a company, the true value of the option is unknown. Granted, the company will be valued by HMRC (in the UK) and by investment rounds, but neither of those events are a cards-on-the-table, take-it-or-leave it sale of the company which can result in a successful return.
Yet, two-thirds of companies are giving out a valuation estimate when offering options to employees. Perhaps the answer is simple: these are estimates based upon valuations arising from incoming investment. Still, it seems pretty dangerous to be throwing these numbers around when they’re unproven. I guess startups are dangerous by their nature.
What Trends Can We See?
The conclusions pulled out are:
- If you’ve had a successful return before, you’re more likely to get involved with options again.
- The majority of people understand the technical bits of how options work, with 94% of people knowing what an option is and at the other end 51% of people knowing what a grant is.
- US respondents are more familiar with options schemes and comfortable participating in them, even though fewer people have had a successful return before.
- Almost a quarter of respondents don’t have an options agreement that they can rely upon.
- 12% of respondents haven’t been told crucial details of their package
- Even when a signed agreement doesn’t exist, over half of respondents believed they knew their vesting schedule.
- US schemes were both better understood and also better implemented, with a much higher ‘quality rating’ on the left side of the pond.
- When your options come as part of your initial job offer you have the best chance of getting good quality implementation of the scheme.
I was pleasantly surprised that the percentage of respondents whose options scheme was in good standing (signed agreement/awareness of vesting) was as high as it was (76%/88%). This is good news and as the UK startup ecosystem matures, we should see an improvement in the situation.
There is more to life than money, and there are plenty of reasons to work in a startup other than options. But if you’re after a big upside and your options are not in a good place, you should know that you’re not alone and things will get better — but for now you are in the minority. Maybe it’s time to talk to your employer or vote with your feet.
Thanks to Katy for proof-reading, the respondents for taking the time to complete the survey and thanks to all who retweeted me. You can download the raw anonymised data from those who gave permission.