You got your dream job! You are working with a startup! A job with stock options! In an industry you love! Welcome to perfect utopia! In order to keep that perfect utopia, you need to protect yourself. The people that often start the company are often not the one’s there when the bell rings for the IPO.
Startup companies that are smart, hire people for the immediate need but also hire people that can grow into the upcoming roles. In some cases an early employee solves an immediate pain point for the company. They are a utility employee and can do things from office management to customer service. Over the course of three to five years they help the company grow. Inevitably the company sees a downturn in sales and needs to cut employees. At a certain stage of growth the company has hired specialists for every area and now the utility player is left without a defined role. That leads to a job loss for our utility player.
This utility player joined the company with the ability to receive equity options. In some cases this is the benefit that kept them in the role and perhaps allowed them to take a lower salary. Now faced with a job loss, the utility player will have to come up with the money to buy the options they are entitled to. This cash expenditure is not something they can afford at this time.
In order to mitigate this painful activity, you need to have a discussion with the company about the ability to have an immediate vesting of your options and be a part of any severance package. After all you helped the company grow from nothing to an on going concern that could have a future potential. You deserve to be compensated for your efforts.
If your severance package does not offer you your options and you need to purchase them, you need to make a calcuated decision of whether to buy the options. The decision to buy the options will have the following points to consider:
- Your belief that the company can conquer the market and invent new products for the future
- The cost of the options
- Your current cash on hand
Out of these three items, item number 1 is the priority to focus on. You need to do some deep thinking on whether the company can grow. This assessment will require you to talk to former employeess that left and others that are the target market for the company to learn why they may or may not buy.
In many cases a “fast growing” startup becomes an on-going concern. An on-going concern, also known as a lifestyle company continues to service a niche market with no other products. They provide good jobs for a bunch of people and the leadership continues to believe that some day it will be “big”! If your analysis determines that you are part of a lifestyle company, the probability of a large payday on stock options is very low. To hedge your bet, consider purchasing 50% of the options, but avoid purchasing all of them. Another analysis to perform would be to confirm the number of shares that other departed employees purchased. If other employees are purchasing, this is an indication that others believe in the opportunity.
My story comes from a first hand experience. In 2001, I was fortunate enough to find a startup company and join as employee number 7. I managed to avoid “voluntary seperation” during some difficult times and I am thankful to the management that spared me in every firing decision that took place. I watched several employees arrive with big ideas to help the company and then were ultimately let go for one reason or another. In several cases this was merely a “change in direction” or strategy. For those employees that departed, several of them did not purchase their options. I can confirm that those that did not purchase their options did not miss out on the payday. In the end, the company sold to a private equity firm less than the value of the options. For myself, I had purchased 11,000 shares at .90 cents each and in the end received .65 cents per share. It made for a nice capital loss on the tax return.
If I had to do it again, I would have talked more to the people that had left the company and opted not to purchase their options. In the final paperwork for the purchase of the options, I got to see how many former employees had bought the stock and it was in the single digits.
Joining a startup company has more benefits than just the options. You build something and create jobs. You learn a lot of different roles and it can catapult you to your next role. Along the way, the lure of the options keeps you at the company or you make a decision to depart and leave the options behind. The decisoin to do that is not easy. When you embark on the adventure consider the cash outlay and “opportunity cost” of the purchase. Ideally, negotiate the “gift” of the option in any severance package if your position is eliminated.