The CEO of Carta explains how to value an option grant from a startup.

Henry Ward is the cofounder and CEO of Carta, a startup
that helps other companies manage the stock options grants
they’ve given employees.
Carta

• Henry Ward, cofounder and CEO of Carta, says tech
  workers make a common mistake in evaluating job offers from
  startups.
• Those offers are typically heavy weighted toward stock
  options or other kinds of ownership stakes, rather than cash
  salaries.
• Job candidates tend to focus too much on how much those
  grants are worth in the near term and not enough on what they
  could be
  worth in the future, he
  says.
• Options can offer a huge payoff if a startup is
  successful — but they can also be worth nothing if its fizzles
  out.
  

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Getting a job offer at a startup is exciting. But making sense of
the pay package startups offer can be daunting and confusing.

Big, established tech companies such as Facebook, Apple, Amazon,
and Google often have the resources to pay new hires ridiculous
sums of money. But startups usually don’t. Instead, in lieu of
high salaries, they typically offer candidates equity
in the company in the form of stock options or other kinds of
ownership stakes.

Options give employees get the right to buy stock in a company at
a set price. If and as the company grows and becomes more
valuable, the value of employees’ options can increase.

Understanding how much an offer of options or other equity is
worth starts with asking the right questions, said Henry Ward,
cofounder and CEO of Carta, a
$516 million startup whose service helps companies manage their
equity awards to employees.

Workers considering an offer letter from a startup often make the
mistake of calculating what their stock options or equity grant
is worth today, he said. But that math really doesn’t tell you
much.

“What matters far more than this math is what do you think this
is going to be worth in the future,” Ward told Business Insider.

How to value your options package

To understand what Ward means, consider this scenario: You’re a
tech worker who’s applied for a job at a
made-up company we’ll call Nextably. Nextably offers to match
your current salary and give you some stock options on top of
that.

The value of the salary is self-evident. But not necessarily the
options.

When trying to figure out how much an options grant is worth,
three numbers matter, Ward said. They are:

• The last preferred price: This is the amount
  investors paid per share in the company’s last round of
  financing; it’s essentially what the company is worth per
  share. In Nextably’s case, we’ll say it’s $10.
• The strike price: This the amount per share at
  which you can exercise your options and what you’ll pay for the
  underlying shares. In this case, we’ll say it’s $2.
• Stock options granted: This is the number of
  options the company is giving you, which is equal to the number
  of underlying shares you can purchase at the strike price.
  Let’s say, in this case, Nextably offers you 100,000 options.

Options usually have what’s known as a “vesting” requirement.
Typically, employees can’t exercise any options in a grant until
at least a year has passed and usually only if they’ve remained
at the company throughout that period. Frequently, option grants
vest over a period of four years, with a quarter of the grant
vesting each year.

Let’s say your grant from Nextably has that same vesting
schedule.

On HBO’s “Silicon Valley,”
Nelson “Big Head” Bighetti (right) spent a lot of time doing
nothing as he waited for his shares in Hooli to
vest.
Jaimie
Trueblood/HBO

Here’s where many tech workers would fire up the calculator app
on their phones and make a quick calculation about the value of
their grant:

• The options allow you to buy Nextably’s stock at $2
  per share when it’s already worth $10 per
  share to outside investors.
• That means each option is worth $8 per
  share.
• Because you get 100,000 options in your
  grant, that grant is worth $800,000.
• However, since you’re limited to exercising those options
  over four years, the options grant is worth
  $200,000 a year.

That may sound good or it may not, depending on how things are
going in your current job. If you’re doing well at your gig at
Facebook, Apple, Netflix, or Google, you may believe your current
employer will give you a raise — or even an options grant —
that’s comparable in value to the options Nextably is offering.
So you may figure the extra $200,000 a year from Nextably isn’t
worth the job change.

The importance of looking ahead

But there’s a problem with that calculation, Ward said. It
focuses on the present value of the options, not what they might
be worth in the future. 

Nextably may have been valued at only $10 a share in its last
financing round of financing, but let’s say the CEO says she’s
already planning on raising money again a year from now at $40 a
share.

Let’s do the math on what that would mean for your grant:

• You can exercises your options at $2 per
  share, but the stock will be worth $40 per
  share.
• Your options would be worth the difference — $38 per
  share.
• With 100,000 options, your grant would be
  worth $3.8 million, or nearly $1
  million a year over four years.

When seen from that perspective, that option grant starts to look
a lot more valuable and changing jobs much more worth the effort.

And it could be worth even more than that.

Let’s say the CEO says she expects Nextably to raise funds again
the following year at a price of $120 per share. At that price,
your stock options grant — assuming you hadn’t sold any of your
shares — would be worth nearly $12 million total. That’d be
enough to buy a mega-home even in the San Francisco Bay Area.

Fewer
than one in 100 companies become $1 billion “unicorn”
startups.
Reuters/ Mike
Blake

How to determine if the offer is a good one

Of course, these back-of-the-envelope calculations makes the
assumption that Nextably’s growth and fundraising will follow the
path the CEO is laying out. But that may be a big assumption,
because most startups fail.

In an analysis of 1,098 tech companies from CB
Insights, more than 70% of startups that raised their initial
seed funding between 2008 and 2010 fizzled out, because they
didn’t raise any additional funds and weren’t acquired. The
chances of any startup becoming a so-called “unicorn” with a
valuation of $1 billion or more is less than one in 100, CB
Insights reported.

“When you pick the wrong startup, your stock is worthless,” Ward
said.

So, why should you believe the CEO’s optimistic forecast?

Read more:

A founder-turned-venture capitalist reveals the questions you
should ask before joining a ‘unicorn’ startup

Ward said he spends more than half of his time meeting with
potential new hires for Carta. Of the time he spends recruiting,
90% is dedicated to “helping [job candidates] understand what the
value of stock could be and what it could mean to them
financially,” he said.

He typically gives them the same presentation, or pitch deck, he
shows Carta’s investors. Ward runs them through the company’s
metrics, the investment thesis of the venture capitalists that
back Carta, and his justification for the company’s next round of
financing. He explains why he thinks Carta will be assigned a
particular — generally much higher — valuation when it next
raises funds.

Ward encourages anyone considering an offer letter from a startup
to ask for the company’s last preferred price, strike price, and
the trajectory of the business. He says job candidates should do
their own independent research, too.

“Not all stock is created equal,” Ward said. “What matters far
more than how much you get is the quality of that stock. And most
people treat it like dollars, like it’s a commodity. They’re
trying to get a larger slice of the pie [rather] than the right
pie.”

See also: