How to Value a Job Offer with Stock
Many companies, especially technology startups, include stock as part of the job offer. But it can be hard to assess the value of the stock if the company is not yet public because there’s no market price or way to sell the stock. For example, suppose a person receives a job offer from an early stage startup with a salary of $100,000 plus 40,000 shares given over the course of 4 years. Is that a good offer or not?
To understand the value of stock in a job offer, you may need to ask for context.
This post is written for an employee of a pre-IPO company who wants to understand the value of their equity. I’ll discuss why a private company can’t simply state a value, and then I’ll suggest some questions to ask. This post gives a framework for coming up with a total annual compensation amount, illustrated by a specific example. Finally, I’ll discuss the risk that a stock ends up being worthless. Note that I’m not a financial professional, and this post doesn’t get into tax implications or topics like ISOs vs. RSUs.
My background is as a software engineer. I have worked at companies at all stages — garage, searching for product-market fit, growth stage, and public — and most of these included equity as part of the job offer. Some of these startups weren’t successful. One company I worked for, SurveyMonkey, did well and went public. I’m very glad that I had negotiated for more stock before joining!
Why can’t private companies give the stock price?
It can be frustratingly hard to pin down the value of an employee stock grant at a privately held company. It’s not that companies won’t tell you, it’s that they can’t tell you with certainty. The share value could be nil if the company goes bust; or the payout could be minimal if the company hits tough times and is forced to sell at a lackluster price; or everyone could pop champagne if the company has a big successful exit. It would be misleading to give guidance about the stock value until then.
Ask about percent ownership and potential exits
When you receive a job offer that has a stock component, ask the recruiting team how to understand the value of that stock. They may have a framework that tells you everything you need to know. Otherwise, you may need to probe to get the necessary context.
What percent of total shares does this stock grant represent?
This tells you how big your slice of the pie is. Note there may be different classes of stock which complicate the answer somewhat; and that you may face dilution if the company raises money in the future (the denominator of total shares increases). This article provides a deeper look into this topic, and includes industry data on typical stock grant sizes.
What does a successful exit look like?
This is a roundabout way of determining the company’s valuation, but in the hypothetical. I think this is a great question to ask when interviewing at a company because it demonstrates you’re serious about understanding the long-term business. If the answer is vague spin around “an IPO or sale,” as a follow-up ask for a dollar estimate for a “medium-good” scenario — is it $100 million? $1 billion? $2 billion?
As a rough rule of thumb, if a company raised VC money then those investors are looking for a ~10x return in less than 10 years. So if a company raised a total of $50 million, you’d expect them to aim for an exit that’s at least $500 million. You can use sites like crunchbase to look up how much money companies have raised.
Estimate the annual value of stock received
Don’t think of stock as a slim-chance lottery ticket for a distant future. You have to work hard to earn that stock, and you’re deciding to forgo other potentially more lucrative opportunities to get it.
Estimate the value of the stock you’ll be receiving each year.
To do this, you’ll need to know what percentage of the company you earn each year based on:
- The total number of shares the company has
- The number of shares you receive each year
Then, you’ll need estimates for:
- What is the company’s target exit value? This need not be the most optimistic number, but one that’s a likely “decent” story.
- What’s the chance that exit happens? (The risk)
Now, you can compute your annual stock value as:
earnings = percentage earned × exit value × risk
Returning to our starting example, suppose a person receives a job offer with a salary of $100,000 and 40,000 shares over 4 years; that means they receive 10,000 shares a year. This person asks the company:
- How many total shares does the company have? → 100,000,000
- What would a successful exit look like? → $1 billion
They can compute that each year, they will receive 10,000 shares / 100,000,000 total shares = 0.0001 of the company’s value.
This person believes that the company has a 25% chance of pulling this off (I’ll discuss risk estimates later). Using the above equation:
earnings = percentage earned × exit value × risk
earnings = 0.0001 × $1,000,000,000 × 0.25
earnings = $25,000
They should value their stock as being worth about $25,000 a year. With their salary of $100,000, their total annual compensation is $125,000.
Of course, the company could argue that the total compensation is actually a whopping $200,000/year, because if the company is successful the employee would have received stock worth 0.0001 × $1,000,000,000 = $100,000/year plus their $100,000 salary. The counter-argument is that startups often fail and the stock could be worth $0; hence the importance of weighing reward with risk.
There’s no good way to know the chance a startup will pan out. According to FastCompany, 75% of venture-backed companies fail to return money to their investors. Even a “sure bet” can go bad.
The chances of failure are higher at the earlier stages of a company’s lifecycle. Employees who join a company earlier are taking on more risk, and should expect more stock. Once a company has a product in the market that is attracting customers and earning money, it’s a better gamble — but there’s still plenty that can go wrong. Here is a framework for determining grant sizes based on role and company maturity.
Come up with an estimate the chance a company will succeed, even if it’s just a guess. Update it periodically based on new learnings. Barring any other information, here’s a crude heuristic I came up with:
- If I strongly suspect a company is going to fail or the business plan doesn’t make sense, then I won’t work there.
- If the company is very young and hasn’t yet launched a product with real users, I give it a ~15% chance of someday having value.
- If the company has launched a product with some traction, but its annual revenue is less than $5 million, I’ll give it a ~25% chance.
- Otherwise, if a company has a working product and significant revenue, I’ll give it a ~35% chance.
I never give any company more than 50% odds, no matter how well it is doing.
In spite of the difficulties and vagueness around assessing the value of an employee stock grant, it is a very good practice to give employees stock. Equity grants align employee incentives with the company’s:
- People act with a greater sense of ownership when they have a stake in the long-term success.
- Startups often fail, but potentially have a big payoff. It’s fair that if everyone works to overcome the risks, they share the reward.
- Stock grants can make up for lower startup salaries.
Unfortunately, companies sometimes include stock as part of the job offer without doing a great job of explaining what it means and why it matters. This could come across as disingenuous or give the impression the stock doesn’t matter. The truth is that while the intent of stock grants is well-intentioned, determining the ultimate value is complicated and requires being comfortable with crunching the numbers for low-probability-big-payoff scenarios.