Equity Grant Math
I saw a tweet yesterday that said:
I wasn't sure how to take it, so I took it as a compliment, particularly given the roll that Chris is on right now on his blog.
His most recent topic is equity grant math. In that post Chris states:
Chris is right that the most important number in a grant of equity is the percent of the company that is being granted to you. Earlier this week I got an email from one of our portfolio companies with option grants to approve. It listed each person's name, their job description, and the number of shares they were being granted. It was a nice presentation but I couldn't approve the grants because it did not show what percent of the company each grant represented. I had to go look up the latest cap table, get the fully diluted number of shares outstanding, and add another column detailing what each grant was in terms of percent of the company. Then I was able to approve the grants.
But I need to differ with Chris on one thing. The total number of options or shares being granted isn't totally meaningless. If you multiply them by the share price paid by investors in the most recent financing, you'll get a sense of the "investment value" of the grant. That's the "money at work" you have in the deal by virtue of your employment.
Some will say you should multiply the number of options or shares being granted by the exercise price, but the exercise price is often much less than the last round financing price. That difference between financing price and exercise price is valuable to the option grantee and represents the difference between the value that the company was able to get a valuation firm to place on its common stock and the value that the company was able to get an investor to invest in preferred stock. It is certainly true that common stock isn't worth as much as preferred stock, but it is also true that the third party valuations that companies obtain are often conservative.
The other thing that you need to know is this percentage is likely to decline over time as the company dilutes to raise additional capital and recruit additional people. It is very hard to say what an appropriate amount of dilution you should expect. It depends a lot on what stage of the company is at when you join. If it's getting close to an IPO or exit, you may be spared any dilution. If you are one of the first ten employees, count on being diluted at least in half and possibly more. Everything else is in between the two.
Like all great blog posts, the comments to Chris' post are fantastic. Make sure to read them when you read his post (and you should read his post).
If after reading Chris' post, his comments, and this post, you are still confused about how this works, please let me know in the comments and I'll do my best to explain it.