❗Stock Options in Startups: How they changed the game forever & how to get your best package❗

I’ve been asked by many friends in startups or considering to join one to write about stock options because they have the following questions:

- What are stock options?

- Are they worth anything or should I just go for a bigger salary?

- How to negotiate the best stock options package for me?

These are among many other questions that I will try to answer to my best knowledge, but in the process I plan to explain to you how & why startups use stock options not just to lure talents, but to solve tons of other issues.

(Disclaimer 1: I will oversimplify things and share only the fundamentals you need to know, so let’s call this a guide for beginners)

(Disclaimer 2: What’s happening in the startup scene in Egypt today is not an ideal case to benchmark things on. As I mentioned in previous articles, the salary scales are broken, the titles are inflated, the stocks allocation in many startups are questionable and sooner or later the market will need to readjust!)

HOW STARTUPS USE STOCK OPTIONS?

When talents jump from an established company to startups, they are giving up on a stable career with a clear succession plan and a decent salary. (that will never make them poor or rich probably but will guarantee they live comfortably).

Startups understand this very well! They know that from your perspective as a talent, you’re putting everything on the line and you need to have a BIG payday, otherwise it just makes no sense to join them in the first place.

Startups also know that in their early stages their cash is limited and budgets are too tight to be spent on a competitive compensation package to hire anyone.

This is where stock options enter the picture as the secret weapon to solve their problems. (& along the way change how the brain of these talents are wired making them feel like legit owners who will fight for the startup to reach unprecedented heights)

So, what problem do stock options solve for startups?

Reality: Most startups need to attract top talents (& founding team members who aren’t co-founders) who will allow them to achieve stretched goals within a certain time frame. When and if they achieve these results, they can raise another round of investment which means survival & growth! This cycle repeats itself and more talents are required to be hired and retained until the startup is actually worth something.

Problem #1: With a simple google search, these talents will realize that according to FORBES 90% of startups fail in their first year. Why would they want to take the risk?

Problem #2: Even if they decide to take the risk, these top talents are highly compensated in their companies and have no incentive to leave their current packages.

Problem #3: Assuming they join you, how will you be able to retain them if another company offers them a better package?

Problem #4: If hypothetically you were able to hire many of these top talents, how can you align all of them on the same vision considering their different backgrounds and personal agendas?

(You see what founders and HR teams in startups have to deal with?)

THE STARTUPS PITCH TO TALENT!

Startups do not only have to pitch to investors to get funds, they also have to pitch to top talents to hire them. The hiring pitch goes something like this:

- We have a tech product that can scale massively

- Our market size is huge and we plan to expand outside of Egypt to MENA, Pakistan & India

- Our founders have a strong track record in scaling startups and are well connected to investors and/or used to work as consultants in one of the big 4 consulting firms

- All the projection and trends indicate that this will be x dollar industry by 2025!

Given all these factors, we know we’re going to be a unicorn within the next few years!

We will try to give you a good salary, but if you have to downgrade your current package or you feel the trade-off is unfair, don’t worry, we got you covered!

We will give you stock options that you will fully own in 4 years (25% ownership after each year you spend with us) and in the right time if we make it and IPO you can sell them at a higher price that what we originally gave you for and so you will cash out a lot of money worth so much more than whatever package you are on today (or will be offered by anyone).

Now before I explain to you in details how these stock options work, let’s take a quick look on how this conversation makes the ecosystem what it is today.

HOW THIS CONVERSATION SHAPES THE CULTURE STARTUP ECOSYSTEM?

Owning stock or any sort of equity in startups is to a huge extent what influences and shapes the startup ecosystem’s culture and makes being a unicorn and achieving a HUGE EXIT a target that everyone drives towards!

1- It makes more talents feel like founders and keener to represent the brand and take it to a unicorn status at any cost because they will win big if this happens

2- The high risk/high reward nature of startups make these talents more inclined to experiment aggressively until they figure out what will grow their startup because they have actually have a proper motive

3- The more senior a talent is and the more they contribute to the growth of the startup they might be given more stocks by the founders, making them late founders which helps guarantee they will never jump ship to elsewhere for a bigger salary because they understand the potential behind the stocks they own: SERIOUS MONEY! They also own these stocks usually after 4 years making them want to stick around for a while to gain something of value!

In a nutshell, stock options allowed startups to be able to hire, motivate, retain and then align the goals of top talents!

Trust me this pitch is extremely compelling to the point that even I feel for it. (& I don’t regret it at all by the way — best decision I ever made)

I STILL DONT GET IT, JUST GIVE ME A GOOD SALARY!

Most talents don’t really understand how these options work, and you can’t blame them because they’re not as straightforward as a paycheck.

You don’t understand how much stocks should you get, what value do they have today, when can I own and sell them, what happens if the company closes, etc…

A lot of talents who are new to the startup ecosystem think that the “IF WE MAKE IT” trade-off is too risky!

You’re asked to put everything on the line and become an integral part of building the company until it’s worth something, but you also know that this startup could fail or in the words of one of my favorite mentors:

أغلب الستارت ابس بتفشل و محدش هيسمع عنها في طبق اليوم، و بالتالي الستوك اوبشنس في معظم الحالات تعتبر سمك في مياه و أنت و حظك

This is why Founders & HR teams really need to be able to educate their talents (especially those coming from corporates) on the power & potential of stock options.

HOW DO STOCK OPTIONS WORK?

Think of the stock options as a paper contract that when given to a talent allows them to buy an number of shares at a certain price during a specific period of time!

Firstly, founders create an ESOP (employees stock ownership plan) by setting aside a percentage of shares in the company to be granted to early founding members & future top talents they need to hire in their journey! (For example they put 10% of the company equity dedicated to this)

Let’s say they tell you will receive 10,000 shares of the startup’s stock options pool. You should know that you will not receive all of your options right away, but rather over a period of time that is called the “vesting period”. Usually it’s 4 years; so every year you will own 25% or 2500 stocks of your 10,000. But there’s a catch, there’s something called a “cliff year”. This means if you leave before your first-year ends, you will own absolutely nothing. You didn’t commit all the way through the first year, so why should we give you anything when you haven’t contributed enough!

Let’s imagine that you spent 4 years in the startup, so now you own 10,000 stock options that you can exercise. “Exercise” means that you can buy these stocks. You will buy them at the price they were when you joined the company, usually called grant price/strike price/exercise price. This price won’t change for you no matter what happens. It’s part of the contract, so if the startup is doing really good or really bad, this price stays as is. The concept is that that after 4 years these stocks values is worth so much more than what they were when you entered. So by subtracting the current HIGH price of these stock from the lower strike price written in the contract the day you signed, you can do the math of how much you can value these stock at.

If the stock today is worth $30/share, and your strike price was $20, then your options will be worth $10 each.

I just need to clarify something:

Until you exercise these stock options, they technically do not have any real value.

Your startup needs to get acquired or to go public (IPO) because until then these stock options cannot be exercised/sold mainly because they really aren’t worth a lot at this point. (You can’t even really price them accurately at this point). However, when the startup goes public or gets acquired, suddenly your stock options are marketable at a much higher value!

How much your options could be worth in the future depends on two things: the strike price you signed in your contract and future performance/price of this stock.

In general, you do not want to exercise your stocks anyways until they are priced at so much higher that you originally can buy them for. You to pocket a decent profit, so if it’s increasing in value WAIT.

Don’t be fooled by the numbers in your contract though!

If you’re given 10,000 stock option shares in a company with 100,000 total shares, this means that you have 10% of the current pool. But if you are offered 10,000 stock options in a company with 10 million shares, it’s much more diluted in value. So to clarify again, the raw number of options alone doesn’t tell the full story. While the value of the shares is what determines its value but you need to have the full picture.

What the price is can be relatively straightforward while how the price is determined is not.

Also, note that that your stock options have an expiration date which differs from one place to the other. In your contract it will probably say that your stock options expire within 90 days after you quit and leave!

HOW MUCH STOCK OPTIONS SHOULD YOU TAKE?

To be honest, it depends on many factors like your seniority level and what skills and experience you bring to the table. The founders and sometimes even the investors need to approve on anyone taking any sort of stock options.

Some founders give early founding team members equity. (Depending on their negotiation skills, you will find for example CTOs, Heads of Engineering & Heads of Growth getting anywhere between 1–3% more or less)

Use this diagram to know what to do when offered a % equity versue a $ value of stock options!

Stock options in a growing startup that is scaling and raising funds will keep increasing in price and becoming scarcer. As options become more valuable, they become harder for employees to get. This means that if you haven’t negotiated yours and you have a super senior role in your startup, you should probably try to get it now and possibly even at a lower price that what it’s on today. It’s only fair. Note that the original number of shares set aside for stock options decrease over time as a result of being offered to newly hired talents!

NOTE: If the startup decides to create more shares for option grants this will lead to the decrease of the value of all existing shares. Obviously, this will lead the shareholders and founders to reject the concept as they’re the ones primarily losing!

Eventually, shareholders will acts in their economic self interest!

Finally, I hope you remember that most startups fail and their stock options amount to nothing, so before you spend all your energy negotiating getting the best package, make sure this startup has the potential to survive and grow in the first place and also make sure you are really contributing to their growth and owning your metrics!