Sunday, October 18, 2009

Pricing Employee Options

A startup I advise on occasion just repriced employee options 50% higher, while pricing preferred shares lower. On the face of it, it seems skewed, but when you really look at it, it's very skewed. Here's why.

Let's say employee options are priced at .15 cents, and preferred is at .40 cents.  We'll say there are 10 million shares, so that puts the value at around $4 million.

But there is $3 million invested, and the liquidation preferences are set at 2x, so Common won't see anything for any sale of the company under $6 million, and won't see the same price per share as Preferred until $12 million.

So Common = zero for anything under $6 million. And the current value as determined by the preferred share price is $4 million. So Common shares and option pricing should be not much more than zero.

Pricing options has gotten more complex since the introduction of 409A (See Brad Feld's posts about that here). But common sense tells us that you can't assign zero value to Common shares through liquidation preferences, and then charge $.15 per Common option. And that's without getting into more esoteric and nuanced about the superiority of Preferred shares to Common, or situational arguments.

Employee options have nowhere near the value of Preferred, which supports my argument that VCs tend to value their own capital over the people designated to make that capital much more valuable, as reflected in the deal terms.

If you have any insights into this, please post in the comments.

2 comments:

  1. i actually understood that. thank you, great post. -t

    ReplyDelete