Employees in many startup companies receive a benefit of options and dream of the large amount of money they will receive in the exit. What does the benefit mean, why should you pay attention to the contract and what should be negotiated
The benefit of options in a company is common in high-tech companies and especially in startup companies. In the early stages of the company, it is customary to give employees options. As a result, if the company succeeds and sells, may be worth a lot of money. However, options are a gamble and sometimes in the end the benefit will not be worth it at all.
Employee Stock Options Meaning
If you have options you have the right to buy shares. You were buying it from the company at a certain price. If you came to work at the company early in its establishment then the price of the option you will receive will be very cheap. Then you have to take into account that when investors come to invest in the company later then the value of the options you received will decrease significantly – this is called dilution.
Employee Stock Options
For example, if you received a thousand options to buy shares at a certain price and the company distributed 10,000 shares, you have 10% in the company. Once investors enter they will distribute more shares. Let’s say that the number of shares distributed will increase to 100,000 and as a result, your share in the company will decrease to 1%. There is no protection against dilution.
When employees join at later stages, the options they got are to purchase the stock at its fair value at that time. A price determined by what they have invested in the company. Sometimes the value of the company may go down and then the options will be worth nothing. If, for example, the option is to purchase the shares for $ 10 but its market value drops to $ 5, it is not profitable for the employee to purchase the shares at the end of the transaction.
In most plans, the right to exercise the option is after one year of employment. This is called, the vesting period. Usually, assuming no event such as an exit has occurred, an employee has no interest in purchasing the shares. Especially during the employment period because the right continues anyway as long as he works.
Please remember that you have a a limited time to purchase the shares after you leave the startup. Some company allows their employee to complete within 3 months after their termination.
The company made an exit – will the employee benefit?
In order for the options to constitute a very significant benefit, a number of conditions must be met:
- The first is that the employee will enter at the beginning of the company.
- Second, the company will be very successful.
- The third is that the dilution will be relatively low. Although investors entered the amount of money entered was not very large.
These three conditions rarely are accomplished. There are cases of employees who received a lot of money. While a company made an exit but it is a matter of luck.
If there is an employee who is very important to the company he gets some shares. To retain him, the company will continue to give him more options. He then will be able to reach a significant percentage and earn.
Most start-ups fail and do not reach astronomical exits. Even if reading about exits in very high amounts one should check how much has been invested along the way. For example, if a company exits at $ 400 million. But on the way invested $ 500 million. In fact, the employee who had options in the company will probably not see any money from that exit at all.
In an exit situation usually, acquiring international companies do not want to have any more shareholders. Therefore they prefer to give options to their companies. That is, the new company acquires the options from the employees of the startup company. Thus giving them options in its company.
Options in startups are a gamble
The problem with most start-ups options is that they are not traded. They are not sold on the free market and therefore cannot be exercised. On the free market, you can easily buy and sales shares of companies In such companies, beyond the options program “That is, to take out part of the salary and buy shares with a special benefit for the employees. The employees pay money for it . He enjoys the fact that they can sell the shares in situations where they share value has increased.”
If you are enable to purchase or do not wish to take the risk it is within your rights.
However, EquityBee helps startup employees get the money they need to exercise their stock options. Best of all before they expire by connecting them to investors who provide them with the capital to do so.
You can read more about them, in our detailed EquityBee review.
The benefit of options is very acceptable and it also has many benefits. There is a lot of chance for the employee to earn but it is also a certain gamble. The possibility of profit for the employee depends on how many investors were on the way. Most importantly, how many times it was diluted.There are many startups that state that at least 15% of the company’s shares will be for employees, but the distribution among employees is not equal. So it depends on how many employees there are and what the distribution is between them.
What is important to check in an options contract?
There is usually not so much room for negotiation in the options contract because there is a plan for all the employees and not for selecting a particular employee. The purpose of these plans is first of all that the granting of options will not limit the company – that an employee will not be able to prevent, for example, the acquisition of the company. In such agreements it is usually more possible to discuss the private economic matter i.e. to see if the employee can purchase options at the par value of the share or whether he must get the option at the last investment price. If the employee was able to get the option at the face value when there is already value per share this is a tax benefit and the employee needs to make sure what the tax implication of it is.
For example, if the par value of the stock is $ 0.01 and the company does not yet have a market value then the employee will be able to purchase the stock at that value. If, on the other hand, they have already invested and someone bought the company’s shares, usually the employee will not be able to purchase them for less than the purchase price, if he can purchase at a lower price – there is in fact a benefit that the employee may be taxed on. That is, there may be a situation where the employee will be liable to tax on a benefit ‘on paper’.