Before you accept a stock option grant, ask four things: the vesting terms and start date, the grant as a percentage of the fully diluted company, the price per share, and when the board will approve the grant. An offer letter usually lists only the number of options and possibly the vesting schedule.
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.
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 for 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.
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, remember that it can tell you from its capitalization table. 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?
Options are normally granted at the current fair market value of the stock. Companies usually rely on an expert report called a 409A valuation report to set that value, and these reports are commonly refreshed about once a year or after a material event (i.e. another round of funding). The rules vary, so confirm the details with counsel. 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 long delays) 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.
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Frequently asked questions
What is a standard vesting schedule for stock options?
A standard schedule is 25% vested after the first year, then monthly vesting for three more years, fully vested after four. Confirm that vesting starts on your first day, not when the board approves the option.
Why does my option grant as a percentage of the company matter?
The raw share count says little. A 50,000 share grant is only 0.01% of a company with 500,000,000 shares, and you need the percentage to do even basic valuation math.
What is a 409A valuation?
It's an expert report the board relies on to set the fair market value at which options are granted. It's commonly refreshed about once a year or after a material event, such as another funding round. Rules vary, so confirm with counsel.
Will asking these questions hurt my job offer?
The author says showing you are evaluating the offer diligently sends a positive signal to employers. The questions are listed in order of reasonableness, so if you get pushback on the first or second you can re-evaluate your approach.
