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How Employees Value Their Stock Options
Slyfox writes: "Do we over-value our stock options? How highly do you value your stock options? UPenn's Wharton School recently published
an article based on findings from a survey of employees about stock options. They find that many employees over-value their options and often don't fully understand how their stock options work. Are companies using stock options to trick their employees into working for less compensation?"
This is freaking hilarious!
We have people that can automate software to mine data collected from customers, and infer behavior based on such habits (metadata), and collect, retrieve, and process this information in huge data warehouses at light speeds (literally). People that can write software to synchronize plane schedules to avoid flight or landing collisions, and maximize airport resources usage. But yet these same people cannot read their prospectuses, and/or talke additional time to educate themselves in stock option trading and intricasies.
They call them "Golden Handcuffs" for a different reason...
(This is how life was for several friends of mine, at a specific Internet Infrastructure company, in Man Jose)
They joined on Pre IPO, and were offered thousands of shares at a strike price of under $0.10.
Well, long before their shares were 100% vested, they were all worth in exess of 5 Million dollars each... some more than others.
They started cashing out the stock as it vested (one of those 1/60 of total, per month, for 5 years)
After the middle of the 2nd year, they wanted to move on, and do something else, but it would be stupid, because they're bringing in around 70k/month in stock (before taxes).
THEY were bound by the 'golden handcuffs'.
In spite of having more money than they could spend, they were bound to doing 70+ hour work weeks...
One of them bailed early... around March of 2000... one during the summer. The others are still working there, groaning about thier current stock price.....
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Forget Napster. Why not really break the law?
"Remember when the U.S. had a drug problem, and then we declared a War On Drugs, and now you can't buy drugs anymore?"
Anyone accepting stock options instead of proper compensation for a 40-hour work week needs to have their head examined, in this economic climate at least.
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Forget Napster. Why not really break the law?
"Remember when the U.S. had a drug problem, and then we declared a War On Drugs, and now you can't buy drugs anymore?"
Also, one general caveat for anyone who has stock options (at least in the U.S.): Learn about tax implications before you do anything. It's very easy to get screwed if you're not careful with the timing of your exercise and sale. Be particularly careful of the AMT (Alternative Minimum Tax), which can be assessed on the paper gain that you "earn" when you exercise the options, even if their value drops later. Also, even if you are fortunate to have lots of in-the-money options, I strongly recommend not living large until you've converted them into cash in your bank accounts. I know folks who have gotten close to overextending on the basis of their paper wealth, then got hammered by the AMT and/or the decline in the market.
Amen. For this reason, it's best not to exercise until you can sell, even if it means losing options. Exercise them, sell them and pay the tax man right there and then. That way you won't get burned. The cases I've heard of where people ended up a million dollars in arears with the IRS happened in part because of their ignorance. It's not like this stuff is common knowledge. They weren't getting good advice because MOST people were ignorant of this. Then came tax time. Wham! It hit these poor bastards like a freight train. Now hindsight is 20-20 and you see write-ups in financial magazines. They probably felt that they needed to exercise when they saw the price max out. But for reasons I stated in my earlier post, THEY WERE NOT ABLE TO SELL. So they sat on it and then the market tanked. They got double screwed. First, they have worthless stock and second, the tax is calculated on the price they exercised at minus the strike price. Those affected have filed for protection but there's no telling how that will play. I think the AMT should be repealed. Particulrly since options are exercise or lose but then you can't sell at your discretion.
Wansu, th' chinese sailor
There is no substitute for a good wage. Period.
Lump sum bonuses are subject to a horrendous tax rate and no, you don't get it back at the end of the year.
Stock options are a soggy deal for most rank and file employees for a variety of reasons.
1. Only the people in the inner circle get the lowest strike price and large number of shares.
2. There are usually a variety of restrictions placed on the exercise of these options which tend to minimize the profits the employee can make.
Usually, employees are compelled to use a broker stipulated by the company. This allows the company to control the rate at which the shares are sold. One phone call can halt a sell off. In general, the use of a single broker will delay transactions if for no other reason than you can't get anyone to answer the phone.
There are often self-imposed "blackout periods" in which employees are prohibited from selling their shares. These usually occur during the end of the quarter when the quarterly profits are being announced. The ostensible reason given for the blackout periods is to avoid the appearance of insider trading.
3. By now, everyone is familiar with what happens to stock options when companies go under or the stock market crashes but those are not the only things which can exert large downward forces on the price of the stock. A company I worked for was sued because it's officers had stolen source code from a competitor they had previously worked for. The stock value was depressed for 6 years because of this. There are other surprises which can erase paper fortunes.
By all accounts, I was lucky. I sold all the stock I had in my previous employer in '98 and got out while the gittin' was good. I bagged upper 4 figures after taxes, enough to put down on a good car. But I didn't get rich and considering the overtime I put in, this was chump change. Stock options are like a blow job; they look alot better than they actually feel. I definitely believe stock options are a gimmick to hold down salaries.
I'm sorry for honest, hard working people who have been screwed by the market downturn. I feel their pain. But at least this downturn has forced a hugh reality check about all the stock option business. I grew weary of listening to braggarts gloating about their paper fortunes. This downturn has shut them up.
Wansu, th' chinese sailor
This may be a bit off topic but this seems like a good opportunity to rant.
When I accepted the job at my now defunct company I looked at the wages and benefits and saw that they were good enough. I considered the stock options to be icing on the cake. If it paid off it would have made a nice down payment for a house (not in the Bay Area). I'm glad I wasn't counting on them. Now for the rest of the story.
"You'll get nothing and you'll like it!"
These words have become prophetic for those of us hit by the dot-com fallout. About a year ago, a former co-worker of mine related the details of a phone conference held with a client. (Note to those who use speakerphones: They may not put you on hold but merely mute their mike.) Whilst he and his team members--with their phone mike muted--discussed how to continue the conversation, they overheard the party at the other end joking. One of the lines spoken was "You'll get nothing, and you'll like it!"
He said they stared at each other for a moment and gave an 'Oh-my-God-I-can't believe-they-said-that!' look to each other. They were very tempted when they unmuted the phone to repeat those very words back to them. Alas, they did not. They pretended it was never said and continued with the phone conference. Afterwards, my former co-worker related the story to me.
Almost six months ago our company went belly up and everyone was laid off. For me it was a relief. The company had been in trouble for some time now, and had already had one round of layoffs. The uncertainty was over. I'd held on so I wouldn't have to pay back my moving expenses.
On the day the axe fell, many of us gathered at a local watering hole to drink our sorrows away. A few hours later another former employee showed up at the club wearing a T-shirt with the slogan "You'll get nothing, and you'll like it!" with the company logo. How apropos. The company paid us a quarter of what was owed for our final pay period.
I did find out later he had actually had the shirt made a while back. It was just the first time I'd seen it. I believe that slogan should become the motto of all those who tried to cash in on the dot-com boom when it tanked.
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"You'll get nothing, and you'll like it!"
If you wouldn't normally buy the stock from a regular broker or online trader, why would you want to be paid in the stock?
Keep that in the front of your mind: "If I were working at Wal-Mart, would I buy this stock?" If the answer is no, ask for money rather than stock. If yes, go for it.
If you wouldn't buy it normally, what makes you think it's worth anything, other than the say-so of somebody else (who you don't _really_ know) -- it's conceptually similar to fully trusting the salesman who hosts an infomercial on late-night TV when he says it slices and dices and will cut the fat by 80%.
When I worked at Worldcom, I would take options as payment -- Worldcom stock is worthwhile stock. If I had been working at Pets.com, I would not have taken options -- it's outside of my risk tolerance to buy startup-stock.
Potato chips are a by-yourself food.
You have options, they are deep in the money, but you are restricted from selling. You think the stock may fall, or hell, you just want to diversify.
But you're locked.
So buy some out-of-the-money puts, and sell some at-the-money calls (to pay for the puts), and poof, with the zen of the spread, you have locked yourself into a tidy little profit.
When your options mature, you'll have the stock in hand to make your options position whole, and you're out.
The beauty of the costless collar.
Wish I had this problem to deal with ;-). The moral of the story is to talk with a financial professional though. They have an astonishingly large bag of tricks.
Keep this in mind: it is always in your employer's best interest to pay you as little as possible without making you stop working. Any way management can motivate you to work without actually giving you any money is great for the bottom line. Managers also know that money not yet paid is a stronger motivator than money already paid (and spent). While it's counterproductive to think of your boss as your enemy, it's just plain stupid to meander along thinking his or her best interests are the same as yours. By their very nature, they are not.
--
Proud member of the Weirdo-American community.
First, not every stock is a DotCom. There have been many sucessful privately held companies (yes, even technology companies) where employees have made a tremendous amount of money with options over the years (yes, even today). And no, i'm not talking about the widely speculative bets like Yahoo, where you hope WallStreet will view you favorably, and that the herds will keep the market boyant before you sell. I'm talking about companies with proven leaders, substantial income, fundamentally good technology, rapidly growing sales, etc. I happen to have been involved in a few of them. Just because some people are too stupid to tell the difference does not mean that everyone is.
Secondly, when you say "scam" realize that the original investors, the shareholders, are in the same boat (excepting VCs and such with preferred shares) as you are. If your stock is worthless, their stock is worthless too.
Furthermore, your odds DO not suck. Comparing it to gambling is complete foolishness. With almost every form of gambling, your expected value over time is going to be less than what you put in. Not so with privately (and publically) held companies. On the aggregate, you will make more money in significant privately held (as in, excluding mom and pop shops) companies than you will on the NASDAQ, NYSE, or any other diversified index. Granted, you will also take more risk, but that's the nature of capitalism. You want a chance to make more money? Well you have to take more risk, it's as simple as that. More risk != losing, it simply means that your returns are much less predictable and/or volatile.
EEEEEEEEEEEEERRRR. Wrong. Land is just as arbitrarily priced, its value depends on what the market is willing to bear. You can lose lots of money on all sorts of real estate investments. You really can't invest without taking some kind of risk. It's just that simple. While it is possible to take more risk than is necessary for a given (expected) return [e.g., if you're stupid], you generally cannot expect to earn a greater return without taking more risk, past a certain point (e.g., the SML). The bottom line is that just because there is relatively high risk in taking stock options in companies in lieu of salary, be the company private or public, does not mean the person is stupid. If the employee can afford the risk and the expected return is greater (it generally is), it can actually be a very wise investment.
In other words, if you think you're going to win, on the average, gambling, you really are stupid. But if you think you're going to win playing the stock market, you're not necessarily stupid, because you really are more likely to win than lose. It depends on what you invest in, how you invest, etc, but there is a major difference between investing and gambling.
While I agree with you entirely that investing in real estate is also risky, it does not depend entirely on "growth" of the population. If you're talking about investing in upper-middle class neighborhoods, and the upper-middle class is growing (both in numbers and in real dollars), then that land can still definitely appreciate, no matter what the rest of the population is doing. Conversely, growth by means of a large/poor immigration is going to do very little to prop up property values. In other words, even though I would not invest in the real estate market myself, I suspect it will still grow on the aggregate, excluding certain hyper-inflated markets in California and such.
Useful link for more info on options: www.myoptionvalue.com. While there, check out The MOV School.
now we need to go OSS in diesel cars
You might want to keep an eye on your options, all the same. Most companies have option policies that will expire between 3 and 7 years (or so) after complete vesting. It'd be a shame to lose the options (if they're ever worth) anything through simple negligence.
Of course, if your strike price is higher than current market value, there's no point in bothering with the options. Still, it doesn't hurt to keep half an eye on the market, "just in case"
That said, you should be aware that there are a lot of "catches" with ISO (incentive stock options).
1. You have to have cash on hand to exercise them. 500,000 options at $1 for a $100 stock do you no good if you don't have half a million on hand.
2. You have to pay short term capital gains, even if you don't sell. You must pay taxes on the difference between your strike price and the current market price. If the stock went up a lot ($99 in the previous example), you have to pay $36 in taxes per share immediately-- even though you haven't sold your stock yet! People have lost a lot of money on ISO's this way.
3. ISO's are not necessarily honored if a company is sold. If the company is not publicly traded and is forced to sell or liquidate, preferred shares are paid off first. ISO's get whatever is left, which may be nothing.
-m
Can you elaborate on what it means to 'trick' your employees into working for less?
They know what the option plan is, and what the agreed upon salary is before they start. I don't see any room for trickery.
Yes, some may incorrectly value the options, but that's not the company tricking you.... that's you fooling yourself.
So why didn't you exercise? (just curious)
A couple employers ago, I spent 2 1/2 years with a company. When I was hired, I received some options at about $1.24/share. 2 years later (they vested at 5%/month) I called a broker, and he shorted the stock at $10 (where it was currently trading). He then purchased the shares from my company via my options to cover the sort.
On the day the options were actually exercised (on paper) the stock was trading at $14 or so.
So, for tax reasons, I had to pay income tax on $14-$1.24 = $12.74/share, even though I only sold for $10 ($8.74/share profit). That's $4/share that I didn't see a dime from, but had to pay tax on. Shitty, eh?
So in the end, I DID make some good money, and it made up for my measly salary, but that was through luck. Most employees didn't get any real good money out of their options. And it wasn't enough to put me 'ahead' in life. Now, in hindsight, I would have done things a bit differently. Here's what I would have done.
1) Tax accountant is first thing. Understand *exactly* what your risks are.
2) Make sure broker understands *exactly* how you want things done.
And on a general finance note:
If you suddenly get 50 grand or something, don't blow it. Put it away in long-term savings. You'll like it later in life.
You had options? Or shares....
This is not abnormal; even companies going public tend to re-evaluate some stocks. even 1/20th is not uncommon. Large investors dumping millions into the company do not like the idea that a few young developers who've put 6 months of time in will have 10x the stock they will.
I've seen so many people burned by stock options it's not even funny. One of my friends was on the verge of making bank on some stocks, they even had a ticker symbol, and everyone was just waiting for the stock to appear and cash in on the money. Before the company hit their IPO date, they laid off half the company. Needless to say they never went public. People who gave up a large chunk of salary to strike it rich off of stock options didn't even have a job after it was all over. Talk about a waste.
My experience was a better one, although that's not saying a whole lot. I actually did make money off of my old employers stock option program. This was during the period when everyone was making bank on tech stocks. Every week we saw stocks going IPO for $20/share and skyrocketing to over $100. My company gave me 8500 shares of stock at a price of 25 cents/share to be paid when I cashed in on the stock (called the "strike price"). Even if the stock only went to $20/share, I'd still be makin buko bucks.
Well it turned out that instead of going IPO we got baught out, which was fine with me, my stocks were vested, and now I could cash in. I awaited the deal that was to be made on how much our shares would be worth, etc. I still figured I'd make it big.
When the news came back, reality hit me big. We were being offered ONE DOLLAR PER SHARE. Now $8500 is a nice bonus, but after paying my strike price and taxes, I ended up w/ only $3500, a far cry from the six figures I was expecting, since that's about all the company talked about, practically getting people to work there just for stock and the opportunity to strike it rich. On top of that it was a horrid place to work. I put in 3 years for that stupid extra $3500 when I could have had a better job and been paid more to go somewhere else.
3 days after I cashed my option check I quit the company, and did find a better job, and got almost a $10k raise. I will never EVER take stock options again, even if I'm offered them. They don't call them "golden handcuffs" for nothing.
Got Google? The paper linked includes the formula itself, as well as information about its assumptions and justifications.
This is my honest opinion. You may disagree with me.
"Profit Sharing" and "Stock Plans" tie the company's profit to the worker's financial well being. If the company does good, you do good, so you work harder to get a pay off. This means companies dont feel the need to hire managers to make sure people are working which pushes the burden of organisation onto the worker. But at the end of the day you're still working to make someone else rich. Salary + options slavery vs wage slavery. It's still slavery.
How we know is more important than what we know.
Real? Of course not. More accurate than the "real" media? Definitely.
You cannot apply a technological solution to a sociological problem. (Edwards' Law)
And especially in the current market situation (trust me... my last company just folded up their US office because of the market conditions) you don't want to count your options before they hatch.
is there anyone out there with a good success story on receiving options?
anyone with a startup?
The real success of stock options, as I recall, began with Micro$oft. I'm sure other companies were doing it, but Micro$oft was certainly in the forefront of the tech companies doing it.
.com boom, but not as many as advertised. Most of those were on paper and turned to nothing in the following "crash".
Everyone has heard the stories of millionaires made at Micro$oft, and these aren't fairy tales, they're true stories. Micro$oft created more millionaires than any other company in history (sorry, don't have the links on hand to back that up). And some came out during the
Today's smart tech worker should be more concerned with salary and benefits than stock options, especially with companies without an established history.
What you need to remember, as a tech worker, is that stock options are more of a benefit for the company, than for the workers. As mentioned by other posters, you need money to exercise your options. You also have to wait to be fully (or even partially) vested, and that usually takes a few years, at least. Finally, you have to hope and pray that your options are worth something when you exercise them.
For the company, on the other hand, they get to write off the options they provide. It's a huge tax boon for them. Go to Google and do a search on: "stock option taxes microsoft cisco"
As you'll see, they've avoided paying MASSIVE amounts of taxes by using stock option writeoffs. In fact, for 1999, Microsoft and Cisco didn't pay A DIME in federal taxes. Other sites agree with this story, this just happens to be one of the ones I found first.
So, that's my analysis, but hey, I'm only one guy.
I've been with my company since almost the very beginning, and as such I have a lot of options. They will be worth something if and only if the company gets bought or starts trading publicly. What do I value them at? Nothing.
Not that I don't think they're ever going to be worth anything -- on the contrary, I have a lot of faith in my company and what it does -- but I don't know for sure that they are, and even if they are, I don't even have any way of estimating how much they'll be worth.
So my strategy is to treat them like they don't exist. I don't base any financial plans on them, and I make sure that I'm being compensated fairly with a good salary and good benefits. If they ever become worth something, I'll be really happy, and that'll be like a bonus, but until them, I'm not relying on that.
- In Capitalist America, law violates YOU!
From what I've seen in my company, I can completely understand why employees over value their options. All they're doing is taking the number of options they have and multiplying it by the current stock price. They probably don't even know about the exercise price and that they have to take the difference between the two. When I was hired these things weren't explained to me and I (and everyone else) was going around thinking that their X options at $15/share were actually worth X*15, not X*(15-Y).
I'm glad this article clears things up a bit. I'll probably be forwarding this around on monday so everyone knows exactly how this stuff works.
Things you think are in the Constitution, but are not.
- We're a startup, and we're being very agressive about containing costs. Money saved in salary is money we can put towards product development or marketing, which will increase the [potential] value of the company and, thus, my options.
- I'm being compensated at about 80% of what I would be in a different environment, but there are other factors which IMHO more than make up for that. Even so, the money's more than enough to live comfortably.
- The work is hard to classify: I'm gaining valuable experience in many areas simultaneously, and will be more valuable when I leave the company than when I started work.
- My options are a certain percentage of company value at inception; they're 100% pegged to the company's success. If the company dives the options will be worthless; if the company completes its plan the options will be worth Real Money, more then compensating me for the lower salary.
- My labor will help influence, although not determine, the company's success. IOW, if we tank I'm not the fall guy ('less I really fuck up
;).
- We are not now, nor do we ever intend to be, publicly traded. This makes the options more risky but less volatile.
Yes, some companies can use options unethically, and employees should be much more careful about taking them as an alternative to cash compensation or benefits. But in many cases they can be win-win for employer and employee.question: is control controlled by its need to control?
answer: yes
This isn't as much "normalization" as it is "don't take so many drugs when you're designing tables."
Since when did math become unethical?
1. Current price is essentially irrelevant to the value of an option. The difference between the option price and the current price is the relevant measure.
The option price has nothing to do with it (I think you mean the strike price.) See the math
2. Volatility is NOT good for stock options, or for stocks i n general--except in one, unethical scenario, i.e. when you absolutely no faith in your company and are waiting for the right moment to sell all your shares to suckers who don't know any better. When one exercises one's option, more often than not, given the AMT and other archaic tax rules, one will be paying TAX on the difference between the option price and the current stock price. If volatility is high, and the stock later drops (and volatility, of course, implies big movement in BOTH directions), you STILL foot the tax bill--resulting in the possibility of a huge LOSS on the option (say the company's stock price dips into the penny stock range), but ALSO an ONEROUS tax bill (say, at the time of exercise, you made a killing -- but a killing in stock assets that are now worthless).
The price of an option clearly depends on volatility. Consider a option with a strike price of $10 on a stock trading at $10. If the stock has very low volatility (e.g. it will end at either $9.99 or $10.01) the option is clearly worth very little. If, on the other hand, the stock will end at either $1 or $100, then the option is worth quite a lot of money. This isn't ethics, it's math.
Why do these supposed 'experts' on 'Wall Street' always presume to know better than tenured faculty members at one of the best (if not the best) b-schools in the country? If anything, this fellow proves the Wharton profs' point -- people do NOT understand how options work....
I said the article sucked, I didn't say I'm an expert.
Obviously, an option has worth. The price depends on:
Black-Scholes is a simple formula to compute the price of an option given the above numbers. Because most employees can't immediately sell their options when given them, their options are obviously worth less than unencumbered options: the price should be less than the market price. I.e. an option you can sell is worth more than an option you can't sell.
With this in mind, the article makes a couple of errors:
Given the timing of the survey, it is not surprising that stock prices of many of the respondents? firms had fallen during the previous year; the average one-year stock price return (volatility) preceding the survey went down 50%, and the average volatility was 98%.
The change in stock price (down) is not volatility: it is lower stock price. The fact that it happened implies volatility. A vol number of 98% is meaningless: 20% vol means a stock will go up or down by less than 20% two out of three years. 98% implies a distribution so non-normal (i.e. companies going out of business left and right, or growing like rabbits) as to be mere math junk.
The survey question was painfully confusing:
How much cash would your company have to offer you per option to return a fully vested stock option with seven years life remaining"? In other words, "what is that option worth to you?
Huh? I hardly understand that question, and I work on Wall Street. The rest of the aricle is equally painful.
One side note: employees may overvalue options because they know how well their company is doing. If they think it's doing well, they figure the options will be worth money. If it's imploding, they just quit and move to a new job (the survey doesn't see them.) This is classic survivorship bias.
1) Companies are not required to show an options grant in their income statement, but can show it in a footnote in their annual report. This makes the company appear to be more profitable than it really is. Motley Fool article, and part two
2) Deferred taxation. No one has to pay taxes when the option is issued, but they would if an equivalent amount of salary was paid. Business Week article, look a couple of paragraphs in.
3) Risk dilution. If a startup succeeds, the founders are going to be extremely wealthy. They'd much rather give up some of their potential gains in that situation, in exchange for a greater chance of the company succeeding. (Since their paying less salary up front.)
4) Tying the employee to the company. It's expensive to train someone to take over a position when someone leaves. It takes them a while to get familiar with what the previous person was doing.
For these reasons, issuing options can be a win-win, for both the employer and the employee. So even if employees are valuing the options appropriately, companies may still want to pay a greater value of options than they would of salary.
For example, say your company has a leading product in a market that Dataquest (ha ha) claims will be worth $5B in 2005, from $500M today. Further, lets say you currently have a 10% market share (sales of $50M), but are gaining on your competitors, and may have as large as a 20% market share in 2005, which would put your sales at $1B, representing total growth of 2000%. From that you can project horrible problems growing the company, which it might not survive, and also the potential for large capital gains. You can also try to guestimate a market cap from looking at companies that have experienced similar growth. You would be pleasantly surprised. Or would have been 9 months ago, and maybe again 9 months from now.
Of course, this assumes that you work for a company that has an established position in an identified, growing market. Most people don't work for such companies. Instead, they seem to be working for people that have this great idea that no one wants to pay for. Companies like that really are worthless.
A well-crafted lie appears unquestionable - Dama Mahaleo
I get an annual allocation of options from my employer. It's a large established company, trading publically. The number of options is fine, the percentage of the company is nil. Before the market downturn (that hit EVERYONE) my options were valuing up to a rather significant bonus, since last year however, they're not worth a whole lot.
....
As a large established company, they're not going anywhere, so I can hold them pretty much as long as I work there. If I take another job, I've gotta cash them quickly, or lose them.
Obviously, there's no way to use them as income. But if the stock goes up again (before I leave), I cash out and get a nice bonus. OTOH, if I leave before they're worth something, I value them up, and build it into a signing bonus or extra salary *grin*. Either way, it's supplemental income, at best.
Bret
Integrity is the key, once you can fake that
(--BOFH)
are why nobody listens to you.
There's no effing reason that your friend had to be a pig and try to save the difference between 20% (the cap gains rate) and 36% (his AMT rate) on what, 3 MILLION DOLLARS? Really, if you've got more than 80% of your net worth in one stock, you've gotten very lucky.
He was looking at earnings of three million, and was trying to nickle-and-dime the tax man. The problem is, he didn't know that he had just entered a new financial plane, where $400K is chump change, and he didn't have the common sense to pay somebody for advice, and his ego was too overblown to listen to it anyway.
Oh well. As my daddy used to say -- "A fool and his money don't deserve each other."
Tech startups were giving out options for *decades* before Microsoft. Microsoft got bigger, but I wouldn't say they were in the forefront. There were several big tech waves before Microsoft got big.
Not that it's entirely your fault you're wrong, mind you -- if you didn't live through it, it would be pretty hard to learn about it, given the way the mass media seem to ignore anything that happened more than three years or three time zones away.
Or a bad broker, or both. Did you do your own taxes? That $4/share difference is a loss on your short-sale, and should have been deducted from your gains.
This article was not targetted at "you option holders". It was a technical article in a finance journal, and even so, I found it completely comprehensible. I'm not an economist, but I do own a copy of the pocket MBA guide to finance.
Ok, so you're a bit ignorant. That happens, and it can be fixed easily enough, so there's no shame in it. But no, instead you choose to rant and rave at the authors for not dumbing down their article to your reading level. That's arrogance, and that's unforgiveable.
The tenor of the responses here are incredibly risk-averse. Obviously you shouldn't forsake eating or paying your rent for stock options, but if the company pans out, that 20% salary you gave up for options could end up coming back to you a hundred fold over the long run. I'm not strictly advocating options to everyone, but you only live once...why not roll the dice?
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The bottom line is that unless you have a good grasp of the economics of the industry in which you are working, you understand your firm's capital structure, and you have figured out the probability of any number of "exit strategies" actually occuring (a big issue since the meltdown), you may not want to forsake too much cash.
Cash is king.
I would agree with you if you had bought the stock from the pool of publically traded companies. However, exercising stock options is a little different IMHO. You aquired that particular stock not through your own "free will", but because you happened to be working for that company. You also have some knowledge of the internal workings of the company, and how much potential it has. It might be in your best interest to dump the stock as soon as you can (taking into account capital gains tax) and diversify your holdings with the money.
For example, in 1995 I went to work for a small startup company that hadn't yet gotten its second round of financing. They gave me two compensation choices: Big raise over what I was already making, plus a lot of stock options, or an even bigger raise ($10,000/year more than the first choice) plus a handful of stock options.
I chose to take the smaller raise and the boatload of options. Why? Because I was single, healthy, and making more than enough in base salary to live well, so the options were just the frosting on the cake. I figured the extra $10,000 a year would be nice, but not enough to be a major lifestyle change (besides, I was working 80 hours/week, so my life didn't have a lot of "style" anyway). But the options, if they panned out, could be worth a lot (the number was large and the strike price was insignificant). My oversimplified mental math was broadly like this: Reasonable value of options if the company has a moderately successful IPO = $100,000 when vested in 3 years. Chance of that happening: 25%. Total value of the options given that probability: $25,000. Or about what I would've made in salary. But I liked the upside potential, so I went for it.
I ended up leaving the company before I vested, so I got nothing. But that's OK; I'm still confident I made the right decision. And in fact, the company enjoyed a successful IPO and is still doing well, so had I stayed, that initial grant would've been worth high-6 to low-7 figures.
Even if the company had tanked, though, I'd probably still make the same decision again. I know how much actual cash compensation I need to live a lifestyle that I'm comfortable with. Once I've got that much coming in, what good is more salary? At that point I'd rather have options so I can have a more direct financial interest in the company. Also, I know that by taking some compensation in options I'm helping reduce the company's burn rate and marginally improve its chances for success. I wouldn't take that loyalty argument to the extreme, because we all know that companies can and do screw people over at the drop of a hat, but at the same time I didn't mind having a little bit of skin in the game; it was good for both of us.
I might well answer differently if my life were different -- if I were 50 and trying to put two kids through college, I could easily imagine wanting the cash instead of the stock. But at this point I'll take the extra risk for the potentially larger return, just as I invest the bulk of my savings in more aggressive places like growth stocks rather than conservative vehicles like bonds.
Also, one general caveat for anyone who has stock options (at least in the U.S.): Learn about tax implications before you do anything. It's very easy to get screwed if you're not careful with the timing of your exercise and sale. Be particularly careful of the AMT (Alternative Minimum Tax), which can be assessed on the paper gain that you "earn" when you exercise the options, even if their value drops later. Also, even if you are fortunate to have lots of in-the-money options, I strongly recommend not living large until you've converted them into cash in your bank accounts. I know folks who have gotten close to overextending on the basis of their paper wealth, then got hammered by the AMT and/or the decline in the market. Don't let it happen to you!
"Biped! Good cranial development. Evidently considerable human ancestry."
First of all, you are not really valuing your options at $0 unless you literally would be willing to give them away for no compensation whatsoever. If I walked up to you and gave you a dollar, would you be willing to sign over all your options (if such a thing were legal)? I didn't think so. The options have some potential future value -- maybe not a lot given the circumstances, but it's certainly more than $0.
As for the restrictions of ISOs: I've had ISOs with a few different companies and my experience is this (YMMV):
1. You don't have to have cash on hand; you can do a "same-day sale" where you sell enough stock to cover the cost of the exercise. To use the original poster's example, you exercise all 500,000 options then sell 5,000 of them for $100 apiece to cover the $500,000 exercise cost. (Actually you'd sell a little more to cover the overhead and commissions etc.)
2. No, you don't have to pay short-term capital gains if you don't sell. You may have to pay AMT (Alternative Minimum Tax), though.
3. True that ISO shares are not necessarily honored in case of sale or liquidation (in the latter case you're kind of screwed anyway); then again, I've worked for publicly-traded companies where ISOs vest fully in the case of a sale, and that can be a sweet deal.
"Biped! Good cranial development. Evidently considerable human ancestry."
What I find is that, even if my stock WILL make me a single dime, the odds of me ever vesting fully, going through the legal troubles, and then actually purchasing the options is quite slim.
Most tech people are quite flighty, at least most I know are, because we tend to evaluate our positions regularly and adjust when things get stale. When job hunting, stock options are one of the last things I factor into my decision. Most of the time I can't even say that I know what my options are actually worth!
It's all about the paycheck...
Of course, don't be stupid and not sign your agreement like me (I'll do it soon, really).
In a word, yes. Most people are completely clueless outside of their chosen field. Maybe they know some trivia they retained from classes or books, but generally speaking, unless they have actually spent time dealing with stocks, they don't understand them.
"Here have all these stock options instead of a raise! By the way, they won't be worth much of anything until four years from now, but then they'll be worth a lot!" Let's here it for vested-stock options that never vest because the company goes under/gets bought out/merges/whatever.
I'd rather have the raise.
Kierthos
Mr. Hu is not a ninja.
Scott Adams, Dilber Author, said it best. Stock options are just like lottery tickets. They have a chance at being valuable, but most of them are worthless.
If I ever got a job that offered stock options I would flat out refuse them in favor of being paid more cold hard cash. Cash is guaranteed to be worth something. As long as you aren't being paid in Russain rubles that is.
Besides, all the money I save by using free software plus the money they pay me extra means, more hardware!
The GeekNights podcast is going strong. Listen!
I'll take the cash. And for what it's worth, I've been saying that for more than 5 years.
Plus if there is a problem, you have all of your eggs in one basket.
Not all startups are dot coms, but a lot of businesses fail for a variety of reasons, even if it was a good idea, even if there were good people at the top, even if you yourself worked hard.
Stock options are the carrot the workers see, and it's always good management to show the carrot instead of showing the stick. You want your employees to work hard, like it was their own company. Slackers bring everyone down. So you show them ownership in the company.
It doesn't matter if the owner(s) has any intention of making the company public, if they think you might be bought out, if the market might change, or if they had good intentions from the start. The employee who takes stock options in lieu of real cash is still allowing people to gamble his rightfully due earnings.
Anyone who chooses to gamble a portion of their earnings without having enough cash left over for immediate needs and an emergency fund is stupid. So you work for a place assuming that stock options are worth about as much as the back of the sheet of paper the offer was written on.
If it helps you work hard to think you might be rewarded in the end, well, that's different. But that is the scam. Stock options are worth more to your employer as an incentive to get harder working employees than they will most likely be worth to the employee.
It's your money. You should be able to choose how it's invested. Make sure you get enough cash to handle diversifying your investments, that way a loss isn't the end of the world, and should you lose your job and your investment you aren't left with nothing. If the job doesn't offer enough cash, renegotiate or look elsewhere. Stock options have to be considered worthless until you can exercise them, it's not actually compensation until then.
And by the way, short term capital gains is no different from income tax. I'm not entirely sure why money you make from selling stock should be in some way exempt from income tax... but apparently those who make their money from the purchase and sale of stock have a considerable amount of influence in our gov't (look at what happened to our Estate tax.) In any case, you have to be making a pretty considerable amount of dough in order to have a Federal tax rate much higher than 20% (the long term Capital Gains rate). If you make $100,000 you're unlikely to be paying more than 23% or so. If you're making significantly more than $100,000... well, my heart bleeds :)
One of the reasons that companies love to give these is that they can pass a tax burden from themselves to the employee and thus make their "numbers" look better. Dear old M$ is an example. The company pays NO federal income tax through its use of options. It gets a tax credit for the options that it issues and the employee gets to pay that when they exercise the option. Cisco does the same. While the corporate reasoning is valid, the employees have little understanding of what they are getting themselves into in many cases. All I can say is caveat emptor if you are offered any options, make sure, sure, and very sure you know what the tax consequences of them will be.
Sex is heriditary, if your parents didn't have it chances are good you won't either.
I'd rather work for a privately owned company who are doing well and are respected enough in their field to be a good name on a resume, rather than a stain like some of the defunct dotcoms. An experience in a cool company is worth more than any amount of stock. Take QSSL for example, now that would be a very nice place to have on a resume and they're still privately owned [Yeah, right like QSSL would actually hire you... Ed.]
Your pizza just the way you ought to have it.
Another sort of confusion that occurs with pre-IPO options is due to the fact that many people don't ask 3 simple questions when granted their optins.
1 - What was the market cap of the company at the time the options were valued?
2 - What is the current market cap of the company?
3 - How many total shares/options has the company issued?
You're allowed to ask these questions!!!
With the answers to these questions you can calculate the % of the company that you could potentially own if you exercise your options. Then you multiply this percentage times a market cap to figure out the value of your options. You can also predict the future value of your options if you have an estimate of what you expect the future market cap to be.
Not asking these questions is the same as this sort of job offer:
"We'd like to offer you a job."
ok, what will you pay me?
"50"
deal.
50 what? 50 pesos? 50 apples? 50 mules? you have no idea cause you didn't ask.
In making offers to potential new employees at non-public companies, I'm struck by how often candidates accept (or even negotiate for) their stock option package without asking some of the basics, like what the strike price is, what previous funding rounds were, or even how many outstanding shares there are.
Sure, some of the people are (correctly) taking the bet that if they contribute to the success of our company that they'll be rewarded commensurately. But for others (particularly those who ask for more shares in their offer), it seems that a big number is all that matters. How much is 25000 shares of a private company worth (other than zero if it goes under)? Well, it makes a big difference whether there are 10M or 100M outstanding shares.
Invisible Agent
Invisible Agent
This post is a mirror; when a monkey stares in, no hacker gazes out.
I worked at a medical startup for five years. My options got up to about $300k in value. Then the venture capitalists came in and the president/CEO of the company started taking too many cruises in the Caribbean. This is before a single dollar of income was ever earned.
Venture capitalists pressured the President/CEO to get the product out the door. The product was NOT ready.
Went as far as this: The presidents on a damn boat by Puerto Rico telling me to roll the product out. I said "It's not ready". He says "I'm the president of a multimillion dollar medical product manufacturing company, and you are second guessing me?" (Sure... multimillion.. right... I'm not sure VC investments count there buckko.)
lol.. Naturally the dumbass Venture Capitalists got their way, and our FDA medical approved robotic device FAILED on numerous patients. Darwin's theory was in full swing.
My $32,500 strike price in stock would have bought me $300,000 in stock at the height of it all. By the time the venture capitalists and Captain Ahab in the Caribbean were done, my $32,500 would have bought me $3000 worth of stock. They left the company at 1% of the value of the glory days.
My new company I work for just gives fat stock options to executives, and flips worthless little puddles of stock options to us common folk.
From our friends at The Onion:
t oc k.html
"Dot-Commers to Receive Unemployment Benefits in Form of Stock Options"
http://www.theonion.com/onion3720/dot-commers_s
What were you expecting?