The Option Fallacy in Recruiting

"You better cut the pizza into just 4 pieces because I couldn’t eat 8"
— old punchline

I was out at dinner tonight with a number of local CEO’s and VC’s and the topic of options during recruiting came up. The consistent theme was that employees, in comparing offers from different firms, look at the number of options versus the value of the options. So, in a comparable economic transaction, if Company A had issued twice as many shares as Company B, it could offer 10,000 options as an equivalent to Company B’s 5,000. And, many recruits would find A’s offer more attractive even though they were worth the same (assuming similar preference, market/strike price differential, etc).

My experience has been very similar. An employee will view a 1,000 option grant more favorably than 500, and 10,000 more so than 5,000. Assuming that you don’t end up with a silly number of shares outstanding, you can reach your target level by using stock splits. If your average grant is 500 and you want to hit 1,000, doing a 2-for-1 stock split will get you there. It is easiest (and more affordable) to do this during a financing when the lawyers are already redrafting capitalization numbers.

My advice to employees is to avoid the warm glow of this option trap and do the following quick math:
First, you need to collect the right info. Ask your potential firms for the following…amount of preference & debt, see if the preference is participating, number of fully diluted shares, last market price and current option strike price. To figure out the value of your stock:
1) multiple the last market price times the fully diluted share base (equity value of firm)
2) subtract out the preference and the debt from this amount (remaining "common" value)
3) if the preference is participating (investor gets back his/her preference and then participates as if they had common shares), divide your share grant by the fully diluted share amount (your "ownership" percentage). If not, then back out the preferred shares from the fully diluted number (or don’t subtract out preference in #2 above).
4) multiply your percentage times the "common" value to determine your take
5) subtract out the cost of exercising the options (strike price times # of options)
6) this resulting amount is your take at recent market.
You can run this exercise for higher values to see how you would make out at other acquisition prices. You can compare the offers on an apples-to-apples basis. It is possible that a 100 option grant is worth more than a 10,000 grant at another firm.

Entrepreneurs should remember, on the other hand, that there is a psychological hurdle in getting options above 1,000 and even more so above 10,000. Seems silly but it’s true…

2 thoughts on “The Option Fallacy in Recruiting

  1. It seems that it would be in the businesses favor to split their stock enough so that they could give ‘more’ options.

    It’s easy to see how this works. Employee doesn’t want to go home and tell her spouse they offered her 500 options. 25000 makes a much better story.

  2. Correct. I should have add the only caveat is make certain that the company does not end up with 100 million shares of stock after one round.

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