Stock options, vesting, and exercising, oh my
I got some good questions on my livestream earlier this year about stock options for startups!
In case you don’t want to watch, at a high level, here’s what I talk about that might be useful for you:
- Startup Financing: When a startup decides to raise funds, it usually starts with a seed round, followed by Series A, B, C, etc. There might also be a pre-seed or angel round before the seed round. The startup gets money from investors in exchange for ownership of the company. The lead investor in each round decides the valuation of the company and invests a specific amount based on that valuation.
- Strike Price: The strike price is the price per individual share. It’s determined by the company’s valuation and the amount invested. Initially, the strike price is usually small, but it grows over time as the company’s valuation increases. For example, during the seed round, the shares might be worth just a few cents each. However, as the company raises more money, the value of shares increases.
- Ownership: The company is owned by the founders, and then the investors, and then eventually, the employees. When you’re an employee at a startup, you’re typically offered a percentage of the company’s ownership that the investors don’t own.
- Risk vs Reward: Joining a startup at the seed or Series A stage is riskier, but your share price is less, which could lead to greater rewards if the company succeeds. If you join a startup at Series D, for example, it’s more secure, but the share price is significantly higher.
- Vesting and Stock Options: Vesting is the process of earning the right to buy your ownership in the company. Once your options vest, they’re yours to buy until a certain point (typically 30 to 90 days past your last day at the company). If you don’t buy them, they go back into the company pool. If you do buy them, they’re yours forever, even if you leave the company.
- Liquidation: To cash out your shares, you typically have to wait for the startup to exit, either through an IPO or a buyout. When this happens, your shares are converted to cash. Some startups also offer a “buyback” option when they raise a new round, which allows you to sell your shares back to the company at their current value.
- Preferred vs Common Shares: Typically, employees get common shares and investors get preferred shares. Preferred shares are advantageous during liquidation, as preferred shareholders get their money first. More on that here.
Overall, the main thing you need to remember is that investing in startups is always a risk. Companies can fail (and often do, especially in this economy), and when they do, your investment fails with them. But, if a startup succeeds… the returns can be significant! Your equity in a company is a lottery ticket - you may not win, but if you do, the rewards can be huuuge!
If you’d like more information beyond this, I highly recommend this blog post by Julia Evans.
Until next time!