Will Your Stock Options Make You Rich?Understanding Terms is Key

Will Your Stock Options Make You Rich?

A common question that employees and founders have is “What is the value of my equity”. Especially when you hear about companies receiving higher and higher valuations, does that mean riches and wealth for the early employees that have received stock or stock options in the company? This is a critical question for current employees at a startup and for anyone who is considering working for a startup, because you are often forgoing some cash compensation in exchange for the promise of future riches.

Just last month, the founder of Get Satisfaction which got acquired by Sprinklr, took to Twitter to respond to congratulatory messages and say that he and early investors didn’t make a single penny from the $50MM sale. Last weekend, Heidi Rozen, an Operating Partner at leading VC firm DFJ, wrote a fascinating article on her blog called How to Build a Unicorn From Scratch – and Walk Away with Nothing where she wrote about the terms of VC deals mattering far more than the valuation. She wrote:

As I’ve seen over many years and many deals, in all but the most glorious outcomes, terms will matter way more than valuations, and way more than whatever your cap table says. And yet entrepreneurs – often with the encouragement of their stakeholders – optimize for the wrong things when they negotiate their financings.

The whole article is a must-read for anyone considering starting a company.

Michael Dempsey from the site CBInsights, has built a really useful google docs spreadsheet to help employees model the value of their equity factoring in the various liquidation preferences in place. He also describes his methodology in his blog post, which we recommend reading.

At the end of the day, as an employee considering joining a startup, its really important to look past valuation and make sure to diligence key aspects of the startup in question, including:

  1. The capital structure of the startup, especially if its an early stage company

  2. The governance — who is on the board, who are the investors, what is their reputation

  3. Making sure you have conviction in the company, the product and the strategy

  4. Making sure you have conviction in the management team — both in their ability to manage the company and their overall decision making power

  5. The true value of your equity in a range of scenarios — both positive and negative

These questions may seem daunting but the rewards of working for a startup can be plentiful — professionally, personally and monetarily — and therefore, the time spent understanding the risks is well spent.

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Chris the Climber is a team of Tapwage writers who write about the specific skills that are needed in rapidly evolving careers