How to Evaluate a Stock Option Grant

This is a guest post by Peter Boyd as part of a series on negotiating employment offer letters and compensation.

I recently helped my wife negotiate an offer letter for a senior level position with a late stage start-up and realized that a lot of people don’t understand how to evaluate a stock option grant. Most offer letters describe your title, salary, bonuses and potentially an option to purchase a certain number of shares, but that is all.

Example Document: Sample Employee Offer Letter

Typically, very little information is provided when you receive an option grant in an offer letter. You are usually just shown the number of options you will receive and potentially the vesting schedule. If part of your compensation package involves an option grant you need to ask the following four questions so you fully understand what you are getting.

1. What are the vesting terms and when does the vesting begin?

Vesting allows employees to earn equity over time as incentive form them to stay with the company. For more on vesting see here. The vesting schedule may be detailed in the offer letter, but if it is not you should ask for it. A standard vesting schedule is 25% vested after the first year and then monthly vesting for another three years until you are fully vested after four years. You should also confirm that the vesting will start on your first day, not when the option is finally approved by the board because this can make a material difference if you have “standard” vesting schedule.

Example Document: Sample tock Option Grant

2. What is my option grant as a percentage of the fully diluted company?

A 50,000 share option grant might sound like a lot, but if there are 500,000,000 shares in the company, that is only 0.01% of the company. You need to know what percentage of the company your grant represents to do even the most basic valuation calculations. If the company objects to giving you this information just remember that you can find this in the company’s corporate documents which are public record and held with the secretary of state. I would find it odd if a company would object to giving you this information.

3. What is the price per share of your options?

The Board is required to grant stock options at the current fair market value of the stock. This is normally done by relying on an expert report called a 409A valuation report that is good for a year unless there is a material event (i.e. another round of funding). It is not unreasonable to ask for the most recent 409A valuation numbers, so you have an idea of what your stock is worth on day one. This way you can track the value of the stock over your time at the company with each new 409A.

4. When is the next board meeting and does the company expect the current 409A valuation report to be valid at that meeting?

Stock options are not valid until the board of directors approves the grant. If the 409A is about to “become stale” this can lead to a long delay in the formal option grant (I’ve seen delays of almost a year) and if the company is doing well, the fair market value of the stock can increase rather dramatically. Because this question is also an indirect way to inquire whether the company anticipates any material events in the near future (i.e. raising money or negotiating a strategic transaction), it wouldn’t be unreasonable for them to refuse to answer this question.

I have advised people who are concerned that asking these questions is inappropriate and will jeopardize their potential employment. What I have found is that illustrating you are diligently evaluating the offer letter sends a positive signal to the potential employer. Companies want to hire smart knowledgeable employees. All of these questions are completely reasonable, especially for anyone considering a job above an entry or clerical level position (where equity compensation is much less common). The questions are listed in order of reasonableness so if you get pushed back after the first or second one, you can abandon ship and re-evaluate your approach.