Start-Up Stock Options: Why You Want 'Em, How to Get 'Em

(c) 2000 WetFeet.com

A couple months ago, Erik, a 25-year-old programmer at a small Web design

company, became several hundred thousand dollars richer.

"I didn't even consider how stock options might affect my future," he says. "Now that we've been bought out, I'm suddenly sitting on a pile of money. It's terrific, but if I'd known what I was doing, I could be retired right now."

Erik's regret is common among people at successful start-ups. By negotiating for more stock options up front, you'll have a better chance of leaving your start-up much richer.

The Skinny on Stock Options

Stock options-options to buy stock in a company-allow you to profit from the value you help a company create. They provide an incentive not only to work hard, but also to stay with a company, since only after your options "vest" can you exercise them and buy stock. The vesting period typically lasts four to five years, with 20 or 25 percent of your options vesting after you've been with the company for a year, and additional options vesting each quarter thereafter.

When you exercise your right to buy options, you buy them at their "strike price"-the value of the company when you started. To create further incentives, many companies grant options not just when you start, but also when you're promoted or when you make a key contribution.

IPOs and Venture Capital

High-tech start-ups are dedicated to quickly establishing themselves in a developing market and then having an initial public offering (IPO). While moving toward an IPO, start-ups raise money through venture capital firms. This funding comes in successive rounds: seed money, stage one and stage two funding, and a mezzanine round. Start-ups use this money to establish a niche-to market themselves, build great products, and make deals with other firms. The money raised through an IPO fuels more growth.

At the IPO stage, the strike price rises with the perceived value of the company-a value that's typically way above the value when the company was a month, six months, or a year old.

++++ That means the earlier you sign up, the lower your strike price is likely to be-and the more you stand to make when the big day comes. Internet companies with fewer employees, which are generally just out of the block, often offer more stock options and less cash. Internet companies closer to an IPO are likely to have more venture capital money with which to pay salaries, and less equity to offer. (Read Lessons From the IPO Mania of 1999 for more on options at companies going for an IPO.)

Consider What They Offer and What You Offer

If you're an entry-level employee with an unproven track record, you're not in a strong position to negotiate for many more options than you're offered (though you might offer to trade some of your salary to get more options). By contrast, if you're a savvy programmer with in-demand skills, you've got a lot more leverage.

Lynne, an executive recruiter at a pharmaceuticals company, explains that the higher the position, the more options a candidate is offered. "If you're coming on board as a senior manager, naturally you deserve more stock options than an entry-level candidate. We don't do too much negotiating, but exceptions are made in cases where we think we might lose a valuable candidate."

Many start-ups are willing to be flexible. When Christine interviewed for a business development spot, her offer was presented as a negotiable deal. "They told me that these were the numbers they had in mind-what did I think? It was great to get a ballpark figure that I could then negotiate within."

When Negotiating Options, Ask Questions

The more you know about a company's position, the better you'll understand the value of an options package. Ask questions such as: