Valuing employee bonus stock options in a startup

Question

Oftentimes, a prospective new employee for a start-up is offered stock options as a significant part of their sign-on bonus, if not the entire bonus.

When given an offer, say, of an option for 20,000 shares, what information should the prospective new employee gather, either by asking the company or through research, in order to correctly evaluate the value of the stock options?

Assume for the purposes of this question that the start-up is not known to be imminently pre-IPO, and it's not as simple as searching for a stock valuation - this would be for a start-up in the "quiet" period where the only publicly disclosed information is the funding rounds and amounts, either no revenue or no disclosed revenue.

If it matters, I'm specifically interested in the biotech sector, but would be happy with a more general answer if the information needed tends to be similar across industries.

Answer 1

You'll find many people on this forum who will argue that stock options should be valued at zero, but I think this is an overly simplistic and conservative approach.

Most employers that offer stock options will also give one more valuation scenarios that they use to "sell" you on the stock options to you. Obviously this will be more on the optimistic side. It's still a very helpful exercise to go through. These scenarios are all based on assumptions and you can go through each individual assumption and let them explain to you how this assumption was arrived at. You can judge the "credibility" of each assumption and de-rate the potential gain accordingly.

Things you can ask about:

1. Current share price.
2. Share price history. Share price is typically determined by the board and/or at financing rounds. Look a the trajectory.
3. Plan and timeline to liquidity. Are they planning an IPO? If yes, when and what are the boundary condition that needs to be met?
4. Business plan: when and how do they expect to make money. Is this based on a thoughtful data-driven analysis or more wishful thinking and hand waving. Who is the customer and why would the customer buy?
5. What are they major risk and what is their mitigation plan.

Then try to cross check as many answers as possible using publicly available information. Nothing wrong with using your gut feel as well. Do you buy the story? Would you buy the product? Would your friends or family buy the product/service?

After this exercise you'll have a rough estimate of the potential gain and a likelihood that it's actually going to materialize.

What you do with this assessment is up to you. Stock options are risky so you cannot rely on it as "required" part of your compensation. You always have to make sure that you base package is sufficient. Then again, options are one of the few ways you can actually "make it" and accumulate wealth beyond what you can get with 40 hours/week. It's certainly better than the lottery.