Introduction to Pre-IPO Stock Options

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I’m not an investing guru, I dispense no professional advice, and the only investing training I have is from the University of Google where classes are available 24/7. That being said, I recently had a chat with my girlfriend who was being compensated, in addition to salary, in the form of pre-IPO shares in the company she’s currently working for. Having little to no understanding of the terminology of options, let along pre-IPO stock options, I had to seek an education.

Here’s how it works, you get hired and they give you a option grant – a document that says how many shares you can buy and for how much. The strike price is the price at which you can purchase the shares. The grant date is the date you officially begin vesting and should be on that option grant sheet.

Capital Gains

You have two dates to remember, the grant date and the exercise date. The exercise date is the date you purchase the shares from your option.

If you sell your shares within two years of your grant date or one year of your exercise date, it is called a disqualifying disposition and your earnings will be treated as income. If you sell within one year of your exercise date, it will be considered short term capital gains – taxed at your marginal tax rate.

Lockup Expiration & Blackout Periods

A lockup is a period of time after an initial public offering when pre-IPO shares can’t be sold; check how long you’ll have to wait after the IPO before you can sell your shares. A blackout period is a period of time, usually around earnings announcements and the like, where you can’t trade your shares either. There is an SEC mandated 3 day waiting rule for trading after announcements too.

Okay, now the vocabulary lesson is over…

Evaluating How Rich You’ll Be

You are not rich. Options are worth nothing in an IPO, just ask all the dreamers from the dotcom era, but they have potential to earn something. How can you figure this out? You really can’t unless you have a crystal ball but if you just ballpark how companies in your industry are faring, how you compare to them, you might be able to ballpark a share price if you know how many shares your company plans on IPO’ing with.

Get everything in writing

This is sage advice for everything. Make sure that option grant explains everything, the schedule your shares vest, what happens in a buyout, etc. because while the intentions might be good when the company is performing well, people can get real ugly when the ish hits the fan.

Remember the old adage, “a bird in the hand is worth two in the bush.”

{ 3 comments, please add your thoughts now! }

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3 Responses to “Introduction to Pre-IPO Stock Options”

  1. Kurt says:

    It’s also extremely important to get in writing exactly how many shares are outstanding and the process for granting more. If the majority holders can dilute you down to nothing, that wouldn’t be good!

  2. steve says:

    A few other things to consider with pre-IPO options:

    1. You may see some value in the options even before an IPO, assuming the option plan calls for any type of independent valuation. Barring that, you would like have to wait for the IPO or for some type of corporate transaction.

    2. The Company may in fact have a repurchase clause attached to the grant, so even if you exercise your right to exercise vested options, the Company can buy them back (perhaps even at the price you paid) and there’s nothing legally you can do about it.

    3. Pursuant to #1, if you feel you are in a position of power in your negotiation, you can always ask for accelerated vesting in the even of a Corporate transaction. Many companies will consider this, especially for important hires.

    4. Kurt is correct about the dilution and overhang, but for the majority of people, there is not much that can be done. For Senior level hires or critical talent, consider getting your employment agreement to discuss options in percentage terms of ownership which can be adjusted as the outstanding options change.

    Hope this is helpful.

  3. whitetail slayer says:

    Below is a detailed description of a stock option plan offer that I have and I would like ot knwo if is customary and what questions or addtional details I shouls have regarding stock options.

    “This offer includes a proposaed grant of a stock option to purchase 35,000 shares of company Common Stock. This grant is subject to approval by the Board of Directors. Your stock option will be granted at an exercise price equal to fair market value on the date of grant, with such date of grant generally being the first meeting date of the Board of Directors after your start date. It will have a term of seven years, and vest as to one-fourth of the shares after your first full year of employment and 1/36th of the remaining shares each onth for 36 months thereafter, subject to continued employment. Options cease to vest upon termination of employment for any reason, and shares then vested can only be exercised for three months following such termination”.

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