Stock options
June 21, 2000
Web posted at: 2:52 p.m. EDT (1852 GMT)
(womenconnect.com) -- OK, every time you pick up the paper, you read another story about a young "Net-preneur" counting up the millions he or she just made on stock options. But is that enough to persuade you to quit your corporate job after all these years so you can join that startup that's waving stock options?
Maybe. "We're seeing 20- and 30-somethings become millionaires," says Maureen Callahan, CEO of Callahan Co., a New York firm that advises Internet startups. "If you have the tolerance for risk and ambiguity, clearly you have more experience, so why shouldn't you give it a shot?"
But before you make the leap, look carefully at the fine detail of the options package and the overall salary. Whether you're offered an equity position in a public company or a small pre-IPO group, understanding terminology is your first step toward negotiating a good deal. Here are a few rules for the road to help you get started.
The terms stocks, shares, or percentages of a company generally have one meaning for you: potential money that could be yours for working here. The key word is potential, because you're being offered participation in a company's anticipated success.
In a company that's in the startup phase, "You're banking on the hope that the company will go public and do well," says Susan K. Bishop, president of Bishop Partners, an executive recruitment firm in Manhattan.
"While the potential is there, realistically every company will not do their anticipated IPO, and many that do will not have the huge stock increases that we have seen recently in the news. You stand to be disappointed."
If your new company already experienced a successful IPO, you enter a job in a more stable financial environment, says Kate Hampford, a senior vice president and executive recruiter for Carlsen Resources Inc. in Trumbull, Connecticut. "The appreciation of the stock options you are offered just won't be as substantial as with a pre-IPO."
Keep in mind that in the Internet pre-IPO world, salaries are often greatly reduced, says Bishop. "An Internet start up might pay a top executive a $150,000 cash package, while an existing company may pay $300,000 for the same position."
Many top executives are eager to trade cash for a stake in the company's future. But weighing how much stock to settle for is a tricky business.
Generally, the first people to join the company are arguably taking the biggest risk, so generally they get the largest chunk of the options, at the lowest prices, says Callahan.
While there's no rule of thumb on how much a pre-IPO company may offer you, Bishop and Callahan provide examples of percentages they've seen offered in pre-IPO companies. Callahan notes that in New York, the percentages run higher.
CEOs may receive 2 to 5 percent, says Bishop. In early-stage companies, as much as 8 percent of the company could go to executives, she says. Callahan says that in New York's tight talent market -- amid the high pay of the financial services sector -- that number can rise to 10 percent.
First-line personnel under the president and/or CEO could receive between 1 and 2 percent, says Bishop. "That amount can rise up to 10 percent for the earl-stage key management team," says Callahan. "In New York today, second-line managers, such as global sales managers who report to the executive vice president of sales and marketing, can get 2 to 5 percent," says Callahan.
Remaining staff members could receive under 1 percent, says Bishop.
How do you know how your offer stacks up against others working in the company?
If the company is public, salaries and shares offered to other employees will be filed with the SEC and you can find public documents online using a service such as Edgar OnLine (www.edgar-online.com). The case is a bit more mysterious if the company isn't public. "Unless you are one of the founders or partners, you probably won't know," says Callahan.
If the company is privately held, it may be a little harder to get a clear picture about outstanding shares. First ask how many shares the company has issued, and then ask what percentage was set aside for employees. "You may not get an answer, but it's worth a shot," says Callahan.
What does an "outstanding share" mean to you? Let's say that when a company was started, it created 100 shares of equity in the firm. The company then could have granted 25 percent to the key managers who started the firm; reserved 50 percent of shares to help raise capital; and left the remaining pool for employees. Having this information may help you gauge how many shares are still potentially available for you.
Stock can be given in many forms, and with many restrictions, says Bishop. "It could be an outright grant, which is a gift of stock that the employee does not pay cash for," she says." A grant could be given at any time, for example, as a signing bonus or for outstanding performance." Or stock options could be part of a bonus.
Stock options will be given to you at a "strike price," which is usually the stock's market price on the day of the grant of options, or, in some cases, may be at a discount to that price. (For companies that have not yet gone public, this amount is usually based upon what the shares were valued at during the last round of financing.)
"It's a brave new world. Valuation is anyone's best guess, and it's an art, not science," says Callahan.
Pre-IPO, the biggest contention is between management and investors as to what the firm is worth, or its valuation. In the past, this process was a fairly straightforward comparison based on revenues, earnings, market share and like statistics, explains Callahan. You would then take these numbers from the private company (pre-IPO) and compare it to a publicly traded company in a like market, with like revenues, etc. Then, you could come up with an estimate of valuation, she says.
With the dot-coms -- whose whole play is market share and there's no revenue for years -- there were no comparable companies in the public space, says Callahan.
"Management argues with investors about this and tries to convince valued employees and recruits," she says. "So if you are being recruited, you have to make a determination on how much you trust management."
While you have to trust management in any case, it's more important than usual in this instance, Callahan says, because so much of your future is tied up in futures.
For example, let's say that you receive 10,000 options at a strike price of $10. If the market price is $40 at the time you're fully vested and ready to exercise your shares, you are actually buying the shares at the price guaranteed to you of $10, and then you can immediately sell them at $40. That's a $30 per share profit.
"If the stock goes to $3," Bishop says, "your options are considered 'underwater,' and worthless," she says. Don't forget, says Bishop, that you have a vesting period, during which you have plenty of time to see the value come back, says Bishop.
Unfortunately, there's no way to tell what the future value of your company stock will be. However, the lower the strike price of the stock, the more chance for you to ultimately profit.
Most stock offerings will include a vesting period. "Competition is stiff, and vesting is basically a retention strategy that insures you will stay in a company for a period of time, typically between three to five years," says Hampford.
Pay attention to how your options are tied to the vesting period. For example, some companies may vest you over a four-year period, and give you access to one-quarter of your shares each year.
"If you get in at the CEO level, vesting could be somewhat negotiable. But most companies have a standard vesting policy for their employees," says Bishop.
As with any contract negotiation, having a good attorney is crucial. A tax attorney is important if you're negotiating stock options, since how you set up the deal will impact what you owe the Internal Revenue Service.
"At the end of the day, what we're talking about is free cash flow to you not to the IRS," says Callahan.
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