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Don’t get screwed! Stock option questions you should ask before you join a start-up

September 29th, 2009 · Comments

Lately I keep hearing stories about how employees got screwed because start-up management were very secretive about the companies stock options.

In this economy, a lot of start-up are struggling. VC firms have the upper hand in negotiation. In a lot of cases, the deal terms are very unfavorable to existing stock holders as well as employees.

The problem is that in a lot of start-ups, the senior management teams are not very honest and upfront about stock options. Even in the case of massive stock dilution, senior management teams would still get some incentives unknown to the rank and file employees. Senior management team’s interests are not necessarily aligned with employees’ interests.

If you’re considering joining a start-up, or you’re working for a start-up now, you should have answers to the following questions.

  1. How many shares of stock options have been granted to you? What’s the total number of shares outstanding in the company? Based on these two pieces of information, you can calculate roughly what % of the company you own. What matters is the percentage, not the absolute number of shares.
  2. What’s your strike price?
  3. How many rounds of financing has the company had so far?
  4. As a whole, what % of the company is owned by employees?
  5. In the most recent round of financing, what’s the liquidation preference for the investor? What’s the preferred participation (2X? 3X? or more?) for the investors? These two things could be really damaging for the employees. They allow VC to “double dipping” when the company is acquired.
  6. How much cash does the company have on hand?
  7. What’s the company’s burn rate?
  8. What’s the company’s total revenue, profit, and net cash for the most recent year? What’s Year Over Year growth rate for these four metrics. How does the growth rate comparing to similar companies in the industry?
  9. Is there any public company comparable to the private company? What kind of revenue multiple does the public company has? What kind of P/E ratio does the public company has?

If the company refuses to reveal above information to you, you should think hard if you want to join them.

Start-up is hard work, the risk is high, and probability of hitting a home run is very low. You deserve to know the facts and make an informed decision.

Play hard ball. Make sure you know what you are getting yourself into.

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    Tags: Recruiting & Job Hunting · Start-up Success

    Viewing 3 Comments

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      I have read this posting several times over several days just to let it sink in, and frankly to be sure I did not reply in haste. In the spirit of full disclosure let me say that I am a business owner with employees, and have my MBA (felt compelled to say that since the posting was on GeekMBA360). I am also someone who transitioned from an engineering career into running a successful business.

      I found this article a bit disturbing. My concern with this article is not so much for any mathematical inaccuracies, but rather the tone in which I interpreted the message. The nine points presented were basically correct in their mathematical considerations, but the final statement of "Play hardball. Know what you are getting yourself into" is a poor and disingenuous approach.

      I am all for having the most knowledgeable and educated employees working for both my firm, as well as any other firm. Typically that bodes well for the employer and peer employees. What does not bode well is the “play hardball”. There is a huge difference between having knowledge that can be used to one’s advantage in determining that any offer of employment is personally beneficial vs. playing hardball.

      I am also equally concerned about the following statement contained in this posting: “The problem is that in a lot of start-ups, the senior management teams are not very honest and upfront about stock options.” I do not believe this statement at all. Developing an adversarial relationship between an employer and employee at the onset of employment is grooming that career to fail. Venture Capital Firms, Angel Investors, Private Equity firms, private businesses, etc. are typically run by smart and honest individuals. Clearly there can be exceptions, but they do not represent the majority of investment or venture capital firms (and no I am not an owner of a VC firm, private equity firm, bank, etc.). This statement about the lack of honesty really reflects an issue of integrity and business ethics and should be completely disassociated with any stock option plan that might be offered. Who cares what amount of options or warrants you receive if you have to be concerned with the integrity and / or business ethics of the firm you are considering going to work for?

      Individuals and financial backers who start companies successfully as well as unsuccessfully, take on far more risk than most employees recognize. Stock options are just one way of potentially rewarding individuals who decide to join a firm that may not be as established as other competitors. If the motivation for changing jobs or accepting a position is driven primarily or exclusively by the desire of being able to secure greater stock options than your peers, then I would suggest a reevaluation of motivations.
      • ^
      • v
      This is a hell of piece. Very informative. I am currently with a local startup. I was first paid employee (others had been working for a long while for equity plus minimum wage) who got a percentage based options. That is my first time too (paid in % instead of number of shares).

      I am still debating whether it is more of a perception of how you are valued, rather than substance--since either way, a lot of the "true value" of your option is the premium you give to this company: in the projection of revenue growth, the multiples for the industry and cost containment.

      I think your piece helps me to look at this at a different angle: given the same projection of growth, which offer is more valuable than the other.

      Keep up the good work
      • ^
      • v
      Thanks. Start-up valuation is more art than science. :-) Besides the hard numbers like revenue, EBITA, profits (if the start-up has), it also has a lot to do with the overall market condition, and the bargaining power of the CEO/founders. It takes "a leap of faith" to join a start-up. :-)
     

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