Negotiating Small Business Stock Options
Q: I’ve been offered a sales job in a company that has a lot of potential to grow fast and maybe even go public. I’d have to take a cut in salary and benefits, but the founder says he will make it up by giving me a big stock option position. How do I know if I am getting a good deal on the options? How do I negotiate without losing a job I want?
A: At a time when early employees at Facebook and other companies are cashing in lucrative stock options to become giddy millionaires, you are asking all the right questions. Well done!
Ideally, everyone wants to work for a hot company that fosters employee dedication with generous stock option grants. Yet, it is not uncommon for stingy founders to offer early recruits a stock option number that sounds fantastic in size but in reality represents a very small piece of the company’s total “equity pie.”
You can evaluate the strength of the proposed deal by asking the founder for two corporate documents: (i) a copy of the company’s stock option plan and (ii) the company’s current “capitalization table.”
A capitalization table or “cap table” is a summary document that lists all common shares, preferred shares, warrants and stock options that the company has already issued to investors, board members and other employees. You don’t necessarily need to know who owns these shares, just the totals to determine the size of the company’s equity pie and the prices paid for the shares.
The total of all outstanding common shares and preferred shares plus the number of unexercised warrants and stock options represents a company’s “capitalization on a fully diluted basis.” This is the number you need to know first.
Overall, your negotiating objective is to receive a number of stock options that compensate you for the reduction in salary plus a second allocation that represents a standard sales executive stock option incentive package for a similarly sized company.
So what is a reasonable percentage to ask for? Unfortunately there are no fixed rules. The more the company needs your sales leadership, the greater percentage of the company’s equity pie you should receive. Young companies may offer 1% to 4% to a proven sales executive.
Negotiated employment contracts can also guarantee that the executive can additional stock options based on successful annual performance.
Most companies require employee stock options to vest in equal installments over a number of years which is usually about four years. To the extent that the stock option plan allows for some flexibility, try to negotiate the shortest vesting period possible.
Your next consideration is the price per share you will have to pay to convert your stock options into shares of common stock. This is known as the stock option’s “strike price” or “exercise price.” The strike price you negotiate should be close to the market value of the company on a per share basis. Watch out for founders who offer stock options with strike prices that are much higher than the price recent investors have paid for a share of stock.
Another factor that affects the value of an option is the period before stock option expiration. A stock option with a seven year term is more suitable for an early stage company than a stock option with a stingy three to five year term before expiration. Young companies need time to grow and flourish.
If the founder is unreceptive to giving you the company’s summary cap table, then you have learned something important about your potential boss. He is not forthcoming with the details you need to make an informed decision.
Effective CEOs and business founders that lead young companies to greatness tend to attract top talent, treat them with respect and give them the flexibility to carry out their responsibilities. By asking for the company’s capital position, you demonstrate initiative and a level of financial sophistication that is desired by companies on the move. Smart leaders are not offended when equally smart people ask smart questions.
Susan Schreter is a 20-year veteran of the venture finance community and a university educator in entrepreneurship. Her work is dedicated to improving startup longevity in rural, urban and suburban America. She is the founder of www.takecommand.org, a community service organization that offers the largest centralized database of startup and small business funding sources in the U.S. Follow Susan on Twitter @TakeCommand.