Is it ever worth taking options instead of cash?

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FireProof
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Is it ever worth taking options instead of cash?

Post by FireProof » Wed Sep 07, 2016 4:01 am

Let's say I have two choices of annual compensation from a start-up with Series A funding

$100,000 cash + $50,000 options (ISOs vesting over 4 years)
$125,000 cash + $25,000 options

At first glance, cash always seems better - it has no vesting period, and no risk. However, the fact that two options are given shows that there must be at least some benefit to the options.

Is it just if I have faith that the company will grow a lot? Basically the chance to invest at an early stage in a promising company?

Is it for tax purposes?

Or are the appraised value of shares lower than the real value? From what I can tell, the appraised value of the shares would imply a total company valuation of around $20 million, but the funding was for $15 million or so already, which would imply a valuation of more like $60 million. But why would the appraised value not be the same? Am I just calculating it wrong somehow?

FireProof
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Re: Is it ever worth taking options instead of cash?

Post by FireProof » Wed Sep 07, 2016 3:12 pm

Hmm, perhaps the difference in apparent valuation is because the funding round is preferred shares, while ISOs are common stock? But a 66% discount would be way too much...

psteinx
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Re: Is it ever worth taking options instead of cash?

Post by psteinx » Wed Sep 07, 2016 3:24 pm

Is it EVER worth...

EVER covers a lot of time/situations, so I would answer yes.

As for your SPECIFIC situation:

Without a detailed understanding of how that option value is determined, folks here won't be able to determine how much (expected) value the options truly have.

FireProof
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Re: Is it ever worth taking options instead of cash?

Post by FireProof » Wed Sep 07, 2016 3:32 pm

psteinx wrote:Is it EVER worth...

EVER covers a lot of time/situations, so I would answer yes.

As for your SPECIFIC situation:

Without a detailed understanding of how that option value is determined, folks here won't be able to determine how much (expected) value the options truly have.
OK, what are the variables that might make it worth it? Assuming they are accurately priced, they seem, on first ignorance glance, strictly worse than cash.

Is it just a bright future of the company, or tax reasons, or is it something to do with (intentional) mispricing?

psteinx
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Re: Is it ever worth taking options instead of cash?

Post by psteinx » Wed Sep 07, 2016 3:37 pm

Well, the valuation is the main thing. You assume they're correctly priced. I am skeptical.

As for possible tax angles, etc - I don't know.

Obviously, in almost every normal situation, certain money now is worth more than an equivalent amount of uncertain money in the future. Vesting, volatility, etc...

But the key question is the real expected value of the options...

limeyx
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Re: Is it ever worth taking options instead of cash?

Post by limeyx » Wed Sep 07, 2016 5:48 pm

It looks like a simple question but the answer is extremely complicated with "what ifs"

What is missing is
- How the options were valued at $50K/$25K (is that #of options * strike price or some "feel good" valuation)
- How many total (fully diluted) shares / options are outstanding
- Strike price
- What happens if you leave (can the company forcibly buy back vested and exercised options at market price or can you keep them)
- How many actual options you will get in # of shares
- 409A valuation of the company

If there are 10M shares and you have 50,000 @ a strike of $1/share then thats one thing
If there are 100M shares with the same, then thats quite a bit less in your favor

The company may or may not be willing to disclose some of the above numbers to you

Most people value options (correctly or incorrectly) on "What if we sell the company for $XBN dollars where X is some nice number > 0)

Also unless the company gets acquired or goes public, you'll have limited ways to liquidate those options after they vest. For the bigger startups, there exist secondary markets (where you may or may not get a good deal, but these can also be limited by your stock agreement)

Whats your estimate of the chances of liquidating at a given valuation ? Does the company have revenue ? Profit ?

But yes, it can definitely be worth it as options have paid for my house and most of my retirement and my boss got to retire in style in his early 40s (but I got really lucky, but it was much more luck than judgement and I was too young and dumb to ask any of the above questions)

I've also had 3 more cases where the options were worthless (or worth less) so your MMV

The good thing about ISO's is in many cases they can reduce tax burden by converting short-term to long-term gains (if you can early exercise and do an 83B election then even better)

You also need to be aware that with a private company, those numbers can change pretty much at any time. If things don't go well and they need to take on a "down round" (investment at a lower valuation) then you can end up with substantially less than you have as the company can easily issue many more options, diluting employees considerably

Also, if the company has a decent but not great exit (lets say you sell for $20M) then the VC that invested that $15M may have first rights on the first $15M of any sale, so instead of splitting $20M amongst VC's and employees, it becomes $5M at best

Also note that the %age of ownership (#of options into the total diluted options/shares) goes down considerably if you aren't in the first small group of employees so once you hit around 50+ employees, the percentages start to drop (for an engineer in a tech company you are looking in the low single digit percentages say < 0.2%) multiply that by whatever payout you can imagine to see some range of possible results you might get ...

Also more and more companies are delaying an IPO these days which also contributes to lower liquidity on those options

ralph124cf
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Re: Is it ever worth taking options instead of cash?

Post by ralph124cf » Wed Sep 07, 2016 10:54 pm

Except for start-ups, most companies have options that trade on the open market. If possible, check to see what similar options are selling for to determine if your options are more or less valuable. The primary variables are duration and exercise price versus current price.

Ralph

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Tamarind
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Re: Is it ever worth taking options instead of cash?

Post by Tamarind » Thu Sep 08, 2016 9:18 pm

I would generally value options for a private company at $0 unless you have a lot of valuation info available to you beyond what is available to the public. Purely based on the odds of failure for companies of that age.

I've had one set of options go to zero (fire sale), and one set, not exercised yet, appear to have doubled based on new strike prices and may end up much higher, but it's very hard to tell how much dilution has occurred in the interim.

One seldom sees all-cash offers with the same face value as offers including options. If you don't need the money and like a lottery ticket, sure, take the options. Otherwise if take the cash.

Jack FFR1846
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Re: Is it ever worth taking options instead of cash?

Post by Jack FFR1846 » Thu Sep 08, 2016 9:21 pm

I've been given the choice many times and always take the cash. I've watched options of other engineers go from 140 to 13 and rise up to 15, never to go higher.

Another went from 48 to 12 in 6 months.

These were established tech companies started in the 50s and 60s.
Bogle: Smart Beta is stupid

DoubleClick
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Re: Is it ever worth taking options instead of cash?

Post by DoubleClick » Fri Sep 09, 2016 3:03 am

Options may be worth a lot more but only probabilistically. Posters above have covered the details.

Also note that the spread between your exercise price and sale price is usually pretty wide if the company did well, and that is potentially taxed at long-term capital gains rate if you spend more than a year between exercising and selling, and meet some additional timing requirements. The savings on tax can be quite significant if your marginal rate is high and you have a lot of income through the options.
Last edited by DoubleClick on Fri Sep 09, 2016 11:24 am, edited 1 time in total.

FireProof
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Re: Is it ever worth taking options instead of cash?

Post by FireProof » Fri Sep 09, 2016 6:45 am

Thanks, very helpful. Think I'll stick with the cash, although I can see some of the attractions of the options now.

Tamalak
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Re: Is it ever worth taking options instead of cash?

Post by Tamalak » Fri Sep 09, 2016 7:39 am

Isn't the options market as liquid as cash? Just look up what the options are going for and then valuate them that way. If the options sell for more than the cash, take them and immediately sell them (options are stupid).

CFOKevin
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Re: Is it ever worth taking options instead of cash?

Post by CFOKevin » Fri Sep 09, 2016 10:04 am

In Silicon Valley, it is considered an intelligence test, and, as long as the cash salary is enough to meet your living expenses (including retirement savings), you should take the options. If you don't believe in the future value of the Company's shares, why would you be joining?

What I would do in the case described is get as much valuation info as possible. A 66% discount (your strike price vs. recent price of the preferred is high but not out of the question after only a Series A round). Also, get a sense if expectation have been met or exceeded since the round closed.

Not all options ultimately turn to cash, but all have some value. A friend joined Microsoft almost 20 years ago out of our MBA program. Her starting salary was $48,000 and her initial option grant made her over $3,000,000. And, she joined when they were publicly traded.

Also, when you say $25,000 or $50,000 in options, is that total strike price or some implied current value?

Kevin

limeyx
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Re: Is it ever worth taking options instead of cash?

Post by limeyx » Fri Sep 09, 2016 10:17 am

Tamalak wrote:Isn't the options market as liquid as cash? Just look up what the options are going for and then valuate them that way. If the options sell for more than the cash, take them and immediately sell them (options are stupid).
This is a private company with VC-funding, so the options are essentially non-liquid except in special cases which are not likely to apply here

limeyx
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Re: Is it ever worth taking options instead of cash?

Post by limeyx » Fri Sep 09, 2016 10:18 am

CFOKevin wrote:In Silicon Valley, it is considered an intelligence test, and, as long as the cash salary is enough to meet your living expenses (including retirement savings), you should take the options. If you don't believe in the future value of the Company's shares, why would you be joining?

What I would do in the case described is get as much valuation info as possible. A 66% discount (your strike price vs. recent price of the preferred is high but not out of the question after only a Series A round). Also, get a sense if expectation have been met or exceeded since the round closed.

Not all options ultimately turn to cash, but all have some value. A friend joined Microsoft almost 20 years ago out of our MBA program. Her starting salary was $48,000 and her initial option grant made her over $3,000,000. And, she joined when they were publicly traded.

Also, when you say $25,000 or $50,000 in options, is that total strike price or some implied current value?

Kevin
+1 to this. Even though the possibility may be small, those options could end up being life-changing (hopefully in a positive way)

Tamalak
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Re: Is it ever worth taking options instead of cash?

Post by Tamalak » Fri Sep 09, 2016 1:33 pm

nickambrose wrote:
Tamalak wrote:Isn't the options market as liquid as cash? Just look up what the options are going for and then valuate them that way. If the options sell for more than the cash, take them and immediately sell them (options are stupid).
This is a private company with VC-funding, so the options are essentially non-liquid except in special cases which are not likely to apply here
My bad. In that case my answer is: yes, take the options if they're clearly superior to cash, but that may be hard to calculate.

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DaftInvestor
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Re: Is it ever worth taking options instead of cash?

Post by DaftInvestor » Fri Sep 09, 2016 4:04 pm

You made the statement "from what I can tell". I would find out definitely how many outstanding shares and options there are (of each type/class) and what percentage of ownership they represent. If you are getting options presumably there are preferred shares - do they have some inherent yield that would be paid before any options are paid off? (as is usually the case in my experience - example. - your class B shares will likely never be paid out unless the company can pay out all the Preferred-Shares at a 9% yield when an event occurs).
How many more series of funding does the company expect to go through and how much will that dilute you?
Take the time to research all this. These are all fair questions to ask before making a decision - if the hiring manager doesn't know I'd speak with the CFO. It amazes me how many people join startups and don't understand what their equity is.

crazygrow
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Re: Is it ever worth taking options instead of cash?

Post by crazygrow » Fri Sep 09, 2016 6:46 pm

Life is about taking some risks if you want big rewards. But be prepared for it to not work out or for it to be "just" a learning opportunity. I jumped to a poorly funded start-up in a completely new field at half the pay a few years ago and the first year was rough (I came in at a senior level so I knew that we only had 1-2 payrolls of cash in the bank and any major bump would likely spell the end!), but we made it and while I couldn't retire off what I got, it swung a negative net worth to a decently positive one and I make much more in total compensation today than I would have at my previous career path.

Small amount of luck, tons of work and some great coworkers led to good things. Remember that most VC's will tell you that they are investing in the team, not the product, because the team will be the ones to pull it out or not.

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