Stocks and Options – How to Calculate the “Upside”

Talent is everything. Demand for skilled talent is fiercer than ever, with the gap in supply widening. At Wahl and Case we sit in-between the most innovative, disruptive technology companies as our clients on one side, and an exceptional network of talent on the other. Each day we try to solve a key problem for our customers: how to acquire and retain the best talent, to grow their business. In the world of startups – be it mobile, analytics, ed technology, gaming, apps, monetization, advertising technology, e-commerce, enterprise, shared economy, or financial technology — we’re playing witness to the technological and digital revolution.

As such, we gain valuable insights as to why companies are successful or failing. It’s one of the (many) perks to our job. We intend to pioneer a series of articles, many based on presentations and interviews with thought leaders in our primary markets in Tokyo and San Francisco, to share the insights we get to see in our world of talent acquisition in the tech startup space.

Our goal? To share valuable information that is typically locked inside just a few peoples’ heads. Hopefully, the nuggets of wisdom we share can support a better decision for a critical career move, or even help newly founded startups make their way through the precipitous cliffs of growing a business.

Stocks and Options – How to Calculate the “Upside”

This is where things get more interesting, and more complicated. Why would you leave a job-for-life and join a risky startup? What is the potential upside here? Now we get into the crucial details that may convince a candidate to join a startup. This is where a recruiter’s value can really come into play. But before we go on, here are some more key terms and phrases:

• Stock or Shares: the value of the company is equal to the total value of all shares. For example, if a company issues 100 shares and each one is worth $10,000 then the total value of the company is $1 million.

• Dilution: As the company issues new shares the total stock value needs to be divided by a bigger number of shares. Hence, if we presume that the total value of the company remains the same but more shares are issued then the value of the existing stock is “diluted”. Meaning worth less than it was before.

• Stock Options (often called an ISO or incentive stock option): These are options to buy a stock at a fixed price in the future. They work similar to a futures contract. The price of the stock is called the “strike price” or “exercise price”. For example, a company gives you the option to buy 100 of its shares after one year at $1 each. That $1 is the value of the stock at the time of the agreement. What is important for you, however, is that the stock is valued at more than $1 after this one year. If so, then you can buy the stock from the company at the agreed price of $1 and see an immediate upside. Let’s say, after one year the company’s shares are worth $5 each. Under your agreement, you can purchase your stock option for $1. You can then sell your shares or keep them in the anticipation that the value will keep rising. Either way, you have gained a “free” $4 per share in value.

• Vesting period: Usually there is a period of time that you must stay at the company before you can sell your stock gained from the stock option. Typically this period is 4 years with a 1 year “cliff” and is rarely negotiable. The “cliff” is a period of time before which you have not vested any shares. Therefore in a typical vesting agreement a stock option holder would vest 25% of their shares after 1 year and 1/48th of their shares each month thereafter.

• Upside: But how can I gain from stock options in a company that is not publicly traded, you ask. In a non-listed company, as in one which has shares trading on the Tokyo Stock Exchange or another bourse, the way to gauge the value of its stock is through the two ways we explained earlier. There needs to be an “exit”:

  1) Exit via acquisition – This is when another company agrees to buy your company. The price that it will pay for your company will dictate the value of the stock. The buyer will offer either cash or its own stock (or a combination of both) in return for your shares in the selling company. Typically, big firms tend to acquire for cash.

  *An Important Point – during a takeover the acquiring party will often make special conditions to the seller, including that its key staff do not leave. To appeal to the staff to stay, the acquiring party may even offer additional bonus payments. This is known as “golden handcuffs”. For example, if Company X buys Company Y, it can tell Y that it will pay an extra $1 million if that person stays with the company for at least another 4 years. It may even be structured so that the head of sales personally receives a retention bonus to ensure the person stays at the acquiring party.

  2) Exit via an IPO – as this is a public sale, the price of the stock set by the market via the stock exchange. However, companies often specify to their staff that they cannot sell their stock for at least six months after the IPO. This is known as a “lock up period”. Why? New investors don’t want to see company staff selling their stock all at the same time right once it goes public and driving the price of the shares down. Candidates often don’t remember that immediately after an IPO they can’t sell their stock (options) because of the lock up period. This may make them follow the stock price very closely.

Important issues to consider: What happens if our company gets acquired? What will happen to my options?

Depending on your leverage in an employment negotiation, an employee can negotiate for a “trigger” as part of the stock option agreement. It means that if something that is defined as a “trigger event” happens, the stock option vesting process can potentially be accelerated. You can accelerate the vesting schedule based upon certain events. This is very useful if the company you join is sold or decides to do an IPO before your stock options fully vest.

For example, David get 100 options at $5 per share with a 4 year vesting period from Blue Co. After only 2 years with Blue Co., David’s firm is acquired by Pink Co. What happens to David’s stock options? Should Pink Co. decide they don’t need David anymore, he will only make money on half of his options. With a trigger in place, all 100 of David’s stock options would be vested at the time of acquisition. Unfortunately, these triggers are extremely difficult to get and most companies will not negotiate them into an agreement.

What happens if I get fired after the new company acquires us?

Without a trigger, if you get fired after the acquisition, you will have only the options vested at the time of acquisition and no more.

What if I resign, what happens to my options?

Usually if you resign you will have about 60 days to act on the stock options and exercise. This can be a nice touch. If you leave and take your options, it shows your faith in the business despite leaving the firm.

Are there any tax implications of holding stock or stock options?

Depending upon your nationality, the holding of stock can have especially significant implication on your tax obligations. You should always consult a tax professional when dealing with stock options.*An Interesting case study – can someone sell their stock or stock options to another party? – Chris Sacca made a fortune from buying shares from Twitter employees before the company’s IPO. He set up a fund to buy the stock from them and made billions of dollars.