Evaluating the Stock Option Package

How should you value stock options that are dangled as part of an offer? To a large part it depends on whether the company is an established public corporation vs. a pre-IPO startup.

If the offer is from an established corporation, you’re not likely to be offered very many options unless you’re an executive. So going in as an engineer you might be offered a token amount, perhaps a couple of thousand shares. And given that an established company’s stock is generally not likely to shoot up like a rocket, the value of those options is likely to be modest at best.

If the offer is from an early stage startup (i.e., pre-IPO), you should value the options differently. You should look at the potential size of the company if it’s successful, and the likelihood that it will go public (or be sold). This of course is very difficult to judge, especially for an early stage startup. Hence you may want to pull some numbers out of thin air (that’s what I usually do).

Consider that a hypothetical situation where you are granted 5,000 stock options with a strike price of 10 cents. Such a grant would not be out of line for a midlevel engineer joining a pre-IPO startup.

Say that after four years your options have vested and the company has gone public at $10 a share. Your capital gain on each option would be roughly $10, for a total of $50,000. After capital gains taxes and state taxes your net take might be $40,000. That’s about $10,000 per year for four years of work, which is a nice bonus but not enough to change your life. And it’s certainly not enough compensation if you had to work like a dog for those four years.

And remember, this is in the case of a positive outcome for the company. There are many companies that burn out spectacularly, and many more that just quietly fold.

My conclusion? Consider stock options to be a perk and not an essential part of the pay package. The only exception is if you come in at the executive level and are offered hundreds of thousands of options.