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Episode Date: March 18, 2021
https://youtu.be/sarD-gixczk
Top Insights
- A good way to think about stock options is that you have a 1 in 10 chance of winning the lottery, rather than 1 in millions.
- Post-termination stock option exercise periods can be extended by the company up to 10 years, but very few choose to do this.
- Stock options can be netted out instead of the employee paying out of pocket to buy the shares at the exercise price.
- Startups don't have a lot of cash. So they use their equity as a form of compensation. It gives early employees the hope that their shares may be worth a lot of money in a few years. Most of the time they're worth $0 because ~70% of startups fail, but the other 30% of the time could lead to life-changing, generational wealth.
- ESOP - Employee stock option plan
- When you're forming a company, a percentage of shares are reserved for future employees. 10-20% is usually reserved for future issuances. Until you issue those shares, on a voting basis, the founders own 100% of the company. If you never issue them, you never get diluted. If you don't put enough shares in reserve and you end up needing more shares, it comes from the existing shareholders, pro-rata.
- The only time you can negotiate to have an option pool increase, associated with financing that comes in at post-money, which means investors also share in the dilution with the founders, is if you're an extremely hot company with multiple term sheets on the table.
- In an offer letter, you should use the number of shares being awarded in an option grant, not a percentage. Offering a percentage will create ambiguity.
- It is within the right of the employee to ask how many current fully-diluted shares there are, including the option pool. Also, you can tell them percentages in this case.
- For a standard employee, it's a 4-year vesting schedule with a 1-year cliff. 1-year cliff means you don't vest anything for the first year. It's a test period. You don't want someone who only works with the company for a couple of weeks or a couple of months — to end up on your cap table.
- The employee gets 25% of their shares on their 1 year anniversary. Then monthly vesting of their shares for another 3 years.
- Think about the exercise price of these option grants. People need to know how much they will pay for their shares. The exercise price has to be tied to the fair market value on the date that the board approves the grant, not on the date of the offer letter, and not on the first day of employment. This is why in the offer letter, you need to have a disclaimer that states, "Subject to board approval at the fair market value as determined by the board."
- Fair market value is based on 409A valuation report. Online cap table management services provide this. It is typically less than what people pay for preferred shares. That's because preferred shares have extra rights, namely they have a liquidation preference. This means that if the company is sold they get all their money back first, before the common stock holders get anything.
We have a $10M company. It has 10M shares in it. 20% of the shares were bought recently by a seed fund for $1 each. That is the price of the preferred shares. I, as one of the early employees, own 1% of the company, but they told me I had 100k shares — they didn't tell me 1%. The 409A valuation comes back and they value the company not at $10M, they valued it at $3M. - Jason