I still remember the first offer I received from an early-stage startup. They told me, "You'll be getting 8,000 stock options with a four-year vesting schedule and a one-year cliff." I had no idea what any of that meant. But I wasn't really interested in the opportunity, so I didn't give it much thought.
Then came my second offer, this time from a more established startup. They offered me a certain number of stock options with the same four-year vesting schedule and a one-year cliff. They also talked about how much the equity was currently worth. I was excited about this opportunity, so I decided to do some research. What exactly is a stock option? What does a vesting schedule mean? And most importantly, how much is this equity actually worth?
What is startup equity?
Startup equity is ownership in a company, or the right to buy it, that a startup gives employees in addition to salary. Most employees receive it as stock options, and some receive restricted stock units (RSUs). Either way, you earn it over time through a vesting schedule.
The two types behave differently:
- Stock options give you the right to buy shares at a fixed price, called the strike price. You pay to exercise them, and you only profit if the shares end up worth more than your strike price.
- RSUs are a promise to deliver shares once conditions are met. You pay nothing to receive the shares, though you generally owe taxes on their value when they are delivered.
A lot of my friends were receiving offers from Big Tech companies with around $200,000 worth of RSUs over four years. They were essentially getting an additional $50,000 worth of company stock every year, assuming the stock price stayed the same. They didn't have to pay anything to acquire those shares when they vested, although they would generally owe taxes on their value.
So naturally, when startups started offering me stock options, I assumed they worked the same way. I thought I'd simply receive a certain number of company shares for free over four years. However, stock options don't actually give you shares of a company. Instead, they give you the right to purchase shares at a predetermined price, known as the strike price.
How much are startup stock options actually worth?
When I received my second startup offer, I was told that my equity grant consisted of approximately 4,000 stock options worth around $120,000. In my head, I thought I’d have to spend $30,000 my first year to purchase my first year of stock options.
What I didn’t know was that the value the company assigned to my equity isn’t the price I’d have to pay to purchase those shares. In fact, those two numbers could be dramatically different.
To understand why, there are three important prices you need to know when evaluating startup stock options: the strike price, the fair market value (FMV), and the preferred share price.
| Price | What it is | Who sets it |
|---|---|---|
| Strike price | What you pay per share to exercise your options | Set when your options are granted, then fixed |
| Fair market value (FMV) | The estimated value of the company's common stock | An independent 409A valuation |
| Preferred share price | What investors paid per share in the latest funding round | The latest funding round |
Strike price
The strike price, sometimes called the exercise price, is the fixed price you pay per share when you exercise your stock options. This price is generally determined when your options are granted and doesn't change afterward, regardless of how much the company grows.
If you receive 4,000 stock options with a strike price of $2 per share. That means you'd need to pay $8,000 to purchase all 4,000 shares. And because your strike price stays fixed, you'd still pay $2 per share even if the company's shares became significantly more valuable in the future.
Fair market value
The fair market value is the estimated value of a company's common stock. For private startups, this is typically determined through an independent valuation called a 409A valuation. Since employees generally receive options to purchase common stock, the FMV is especially important.
Let's say your options have a strike price of $2, but the FMV eventually increases to $10 per share. You would still have the right to purchase shares for $2, even though their estimated value is now $10. That means each option has a potential $8 difference between the purchase price and the estimated share value.
With 4,000 options, that's a total of $32,000 in theoretical intrinsic value before taxes and other costs. This doesn't mean you can immediately sell those shares and pocket $32,000. Private company shares are often difficult to sell, and their estimated value isn't necessarily what someone would actually pay for them.
Preferred share price
When venture capital firms invest in startups, they typically purchase preferred shares, which often come with additional rights and protections that common shares don't have. The price investors pay for those shares is known as the preferred share price.
Let's say a startup raises money at a $300 million valuation and has 10 million fully diluted shares outstanding. Assuming that valuation is its post-money equity valuation, that works out to approximately $30 per share. This is a simplified example of how a preferred share price can relate to a company's valuation.
Remember when I said my 4,000 stock options were supposedly worth $120,000? That's exactly what you get when you multiply 4,000 by $30.
But here's the catch: just because investors paid $30 per preferred share doesn't mean your common shares are worth $30 each. Preferred shares often carry protections that make them more valuable than common shares. That's one reason a startup's common-stock FMV can be significantly lower than its preferred share price.
The preferred share price can still be a useful reference point. It tells you what investors were willing to pay for a different class of ownership in the company at a particular point in time. But you shouldn't automatically treat that price as the amount your employee stock options are worth today.
Vesting schedules
Vesting is the process of earning ownership of company shares or the right to exercise stock options over time. A vesting schedule is simply the timeline that determines when that happens. One of the most common schedules you'll hear about is a four-year vest, one-year cliff.
Here is how it works with a grant of 1,000 units, which could be options or RSUs:
- Year one (the cliff). You vest nothing until you complete your first full year. At that point 250 units, or 25% of the grant, vest at once.
- Years two to four. The remaining 750 units vest in smaller steps, often monthly or quarterly.
- End of year four. All 1,000 units have vested.
The idea behind vesting is pretty simple. Companies want to incentivize employees to stick around. Rather than giving employees all their shares upfront and allowing them to leave shortly after, vesting encourages them to stay and contribute to the company.
Putting it together: a worked example
Let's go back to my original example. Imagine receiving 4,000 stock options from a startup with the following numbers:
- Strike price: $2 per share
- Fair market value: $5 per common share
- Preferred share price: $30 per preferred share
With a strike price of $2, exercising all 4,000 options would cost me $8,000. Using the common-stock FMV of $5, those shares would have an estimated value of $20,000, meaning my options would have $12,000 in intrinsic value before taxes and fees.
But if the company were to present my equity using its $30 preferred share price, it could describe my grant as being worth $120,000. That's a dramatically different number from the $12,000 of intrinsic value calculated using FMV and strike price.
Neither calculation tells me exactly how much money I'll eventually make. The actual outcome depends on what happens to the company, whether I'm able to sell my shares, future dilution, investor preferences, taxes, and a bunch of other factors.
So, is startup equity worth it?
Treat startup equity as a lottery ticket you have some control over, not as part of your salary. Cash pays your rent. Equity might pay off in several years, and it might pay nothing.
