How to Make the Most of a Startup Employee Stock Option Program
Going to work for a startup involves a number of compromises. While some startups succeed in a spectacular manner — think Facebook, Amazon and the rest of the FAANG stocks, many more disappear entirely — think Pets.com and its Internet-bubble era brethren.
When you work for a startup company, a lack of job security and an uncertain future are par for the course, but there are potential benefits as well. The chance to get in on the ground floor of the next big thing is certainly exciting, and if you compensated with stock options, it could be financially rewarding as well.
If you are fielding job offers from startups or currently employed by one, it is important to make the most of any stock options you are offered. These stock options can be quite valuable, but exercising them can sometimes be an exercise in frustration.
One of the biggest challenges faced when exercising startup employee stock options is a narrow trading window. Those who have worked for large companies and exercised stock options may assume that the same rules apply and that they have years to exercise their options and lock in the most profitable price.
Unfortunately, that is often not the case. More than one startup employee has seen their stock options expire, losing out on many thousands, or even millions, of dollars in profit.
If you work for a company that is being acquired, not an uncommon occurrence in a fast-growing industry, it is important to read the paperwork carefully. If you are unsure about the trading window or the process for exercising your stock options, ask the human resources department right away — you do not want to leave that startup cash on the table.
The current trend toward delayed IPOs is another major challenge for the holders of startup employee stock options. While startups once rushed to the open market in search of riches and high stock prices, these days the process is often delayed for years, as private equity firms take their profits and the market evaluates the potential of the startup.
In some cases, these delayed initial public offerings work out just fine for everyone involved. The delay in the offering gives the startup company time to prove itself, and that proof of concept can result in a higher opening price and a solid run from day one. When this happens, the holders of startup employee stock options could benefit handsomely — as long as their stock grants not expired.
At other times, the trend toward longer IPO waiting periods can create a real challenge, and a significant loss of opportunity, for the holders of startup employee stock options. Some employees may leave in the interim, losing their stock options and potentially losing out on millions.
Whether you work for a startup that is rushing to the marketplace or holding back, is important to know the rules and understand how startup employee stock options work. The rules are different than those for more established publicly traded companies, and if you do not understand the differences, you could lose out on the rewards you deserve.
From an employee perspective, the most significant disadvantage of accepting stock options in lieu of cash bonuses or direct compensation is the lack of liquidity. Without a current public marketplace, it is difficult to determine the true value of each option. Worse yet, bad news for the company or a change in market condition could lead to the demise of the startup — and the associated stock options.
It is important for the employees of any startup to understand everything they can about the stock options they have been granted, starting with the vesting period and the trading window. As previously discussed, the trading window for startup employee stock options can be quite narrow — employees leaving company may have only 90 days to exercise their options.
The vesting period is another critical factor for holders of startup employee stock options. Startups use stock option grants to attract and retain the best employees, hoping to build company loyalty in the process.
A typical stock option grant may require the employee to remain with the startup for at least a year (known as a cliff) in order to be vested, and even longer for full vesting. For example, a new hire at a startup may be granted 1,000 stock options that vest over a four year period, with one-quarter of the options available to trade at the end of each anniversary year.
In other cases, the employee startup stock options will vest on a monthly basis, with a prorated number of shares becoming available every 30 days after hitting a cliff.
No matter what your vesting schedule, it is important to make the most of your startup employee stock options. Working for a startup, especially an early-stage one, can be a risky endeavor. And while every startup employee hopes that s or her employer will become the next unicorn, a vanishingly small percentage of total startups will live up to this title.
The illiquid nature of stock in early-stage startups is a risk that should not be overlooked, and the risk of failure should be factored into every decision employees and prospects make. For some, the promise of a big payoff is well worth the extra risk, and the lower paycheck. For others, the risk-reward lance is more complicated, and not everyone will be comfortable working in such an uncertain environment.
If you are in line for employee stock options at your own startup, it is important to make the most of the situation. The more you know about how these employee stock options work, the easier it will be to get the rewards you deserve.
Originally Published by Equity Token on Medium