Tell me more ×
Answers OnStartups is a question and answer site for entrepreneurs looking to start or run a new business. It's 100% free, no registration required.
up vote 5 down vote favorite
2

As an employee at an early stage start up company , what are the benefit of stock option vs equity?

It seems to me like equity is far preferable , but is there any advantage to stock option over equity?

(The question can be general, but my background is that I am the fourth employee of a start up company, and I was given common stock options. Since I have been with the company for two years now and critical to their present and future operation, I would like to ask for a bigger slice of the pie. I currently do not know the strike price or percentage of my options partly due to my ignorance and partly due to the fact that I trust the founders. Anyhow, I would like some kind of guarantee that if the company is worth anything, I will get something in return.)

share|improve this question

3 Answers

up vote 3 down vote accepted

First, the difference between the two: options give you the right but not the obligation to buy stock at a certain price (the "Strike Price") within a certain period of time. Stock is the security itself.

Practically speaking, there are differences between the two in an early stage company though they tend to be minor. Here's why:

  • Whether you're granted options or granted stock, both will probably subject to a vesting schedule so your equity won't really be your equity until after some period of time has elapsed. Usually, these vesting schedules are structured in a similar way.
  • In an early-stage company, the Strike Price will be very low, usually in the pennies, so that your out-of-pocket cost to convert the options into stock will be low.
  • Since the options would convert into common stock if you had options, and since you'd be granted common stock if you had equity, you'd wind up with the same underlying security with the same rights.

All things being equal, it's better to have the stock. In your case, the company is two years old and may be past the point where it can grant Founder's Stock to you; you're only practical alternative may be options. That's not the end of the world.

Make sure you understand how many share exist in total (all common shares to all equity holders, the total size of the option pool, and other warrants or options to Board members, etc., the complete Cap Chart) and then you'll know what percentage of the company you'll have at that time, which will likely change as the company raises more capital.

share|improve this answer
up vote 4 down vote

This is important and very common.

First, you definitely need to ask what the number of outstanding shares is, so you can figure out what percentage of the company you own. You should know the price because it should be in a document you signed.

Second, there are no guarantees... Common stock (which you don't even own yet, since you didn't exercise your options), could be washed out by preferred stock. But as an employee, that's how the game is played. You could exercise some of your stock, just to make sure you become a real shareholder, depending on how costly that is. Employees usually prefer to wait, because any money you spend to buy the stock is most likely lost.

share|improve this answer
up vote 2 down vote

There may be a distinct advantage to receiving stock options.

Restricted Stock Shares (and Units) generally cost an individual nothing at the time of award. At the time of vest there is a mandatory income event (without getting into possible 83(b) Election or Deferred compensation scenarios). The income event wil result in taxes being owed at vesting. If the company is still private this will likely be no market to sell the shares and you may be paying out of your own pocket.

Stock Options do have a cost to exercise, but the exercise date is chosen by the participant, not a pre-determined schedule. This gives greater flexibility for financial planning. Also you will generally receive more stock options than you would get for an equal value of restricted stock. This ratio is usually somewhere between 2:1 and 5:1. These added shares create a huge difference in leverage as the stock price grows. At some point in the stock growth, depending on the initial ratio, stock option values quickly outpace restricted stock values.

There are also distinct upsides to restricted stock shares. 1) you actually own a piece of the company. This means that your shares have value as long as the company does (stock options lose their value if the stock price is less than your grant price. 2) Being an owner means you have the rights of an owner, including being invited to annual shareholder meetings. 3) You can file and 83(b) election within 30 days of the award. This may result in a dramatic decrease in compensation that is subject to ordinary income taxes (talk to your accountant or financial adviser first)

The decision is never absolutely perfect, nor is it easy.

Hope this helped. ~Dan

share|improve this answer

Your Answer

 
discard

By posting your answer, you agree to the privacy policy and terms of service.

Not the answer you're looking for? Browse other questions tagged or ask your own question.