Whether you already have stock options or are considering a job offer that includes options as part of the compensation package, you likely have questions about your equity — and that’s a good thing. When it comes to maximizing the value of your stock options and shares, knowledge is power.
Options can unlock life-changing wealth, but many employees typically have the same question: How can you determine the potential worth of your equity?
100,000 options may sound like a lot but it doesn’t inherently tell you much. In many cases, 10,000 options could be worth more. That’s because there are other factors that determine the worth beyond how much you have. Plus, the value can often change as the value of your company changes — hopefully for the better.
The good news is it’s entirely possible to grasp the key points to get a base understanding of the value of your options. Knowing how to value your options can help you feel confident about negotiating a job offer, planning when to exercise and managing your financial future.
Here we’ll walk through a simplified method for thinking about the value of your options.
Step 1: Gather the numbers
Your company should be able to provide you with the following figures:
- The number of options you have per grant (if you have more than one) and the strike price, which may be identical to the company’s 409A valuation (also known as fair market value).
- A sum of the company’s fully diluted shares across all classes. If that’s not available, you could approximate the number by dividing the company’s most recent valuation by the price per share in the last round.
Step 2: Calculate potential gains
Next, you’ll need to choose a number for the company’s valuation at some point in the future. Most people focus on the company’s valuation at exit since that’s often the first time you’ll have an opportunity to sell shares — thereby converting your hard work into cash.
You could certainly also estimate the value of your options today, especially if you are being offered equity at a new job. If you have 1,000 options in a company with 100 million shares outstanding, your ownership stake is .001%. Multiply your ownership stake by the company’s current $1 billion valuation to find that your options are theoretically worth $10,000 minus the costs to exercise (strike price and taxes; more on that below).
Let’s continue with the example, adding in a projected exit value for the company:
You should play around with different figures for the company’s valuation at exit. What would things look like if the company’s exit valuation were 5x its current worth? What if the valuation only grew moderately or even declined in the coming years?
It’s worth noting that our example is simplified and assumes no dilution takes place, which is not always a realistic assumption.
Dilution is when your company increases the amount of outstanding shares. This happens during fundraising when your company issues new shares for investors to buy. Dilution means the exit value would be divided among more shareholders.
Step 3: Calculate your potential gains — after taxes
To arrive at your potential take-home gains, you’ll need to subtract your costs from the resulting gain in the stock's value. Your costs have two parts: the cost to buy your options and taxes.
Let’s start with the cost to buy your options. This is based on the strike price and the number of options. If you have multiple grants, you’ll need to look at these numbers for each grant. Returning to the example above, your future gains rang in at $30,000, but you will have paid $5,000 to acquire shares. So, your projected gains are $25,000.
You’ll also have to pay taxes, which are more complicated and depend on when you exercise:
- If you exercise after an exit (a cashless exercise), you exercise your options then immediately sell your shares without paying anything up front —hence “cashless.” Any gains from the sale is used to cover the strike price and taxes. The ordinary income tax rate is applied to the difference between your strike price and share sale price.
- If you exercise before exit, you’ll pay taxes in two parts — when you exercise and when you sell your shares. Overall, your taxes might be lower in this scenario than with a cashless exercise. However, if your company’s value goes up over time and your options become more valuable, your tax bill will grow, making it more expensive to exercise as time passes.
Check out our Stock Option Tax Calculator to explore various tax scenarios.
So, how much are your stock options worth?
Unfortunately, you can’t be 100 percent sure how much money you’ll make from your options; their value is uncertain.
Here’s one reason why: The higher the company’s exit value, the more valuable your options will likely be. You can try to predict the exit value for your company, but until an exit actually happens, you can't know it for sure. If things go downhill, the company’s valuation could be $0.
Simply put, a successful exit isn’t guaranteed — and exit valuation has a very strong influence on the value of your options.
Timing and liquidity also matter. An early-stage company may have the potential to greatly increase its valuation over time — but this may take several years to materialize, and the road could be bumpy along the way (i.e., the valuation could experience volatility). On the other hand, a company on the verge of an IPO offers a near-term opportunity to experience stock options gains, but perhaps a more moderate valuation upside.
Vesting schedules are another component of timing. Someone with fully vested options is likely to value them differently than another person who just joined the company and is subject to a four-year vesting schedule with a one-year cliff.
Ultimately, every person will weigh these factors differently, which means they will value their options differently. We have several resources to help you continue thinking about the value of your options, including our stock option starter guide. The guide also includes ideas to help you decide when to exercise and how much to spend. Additionally, you can check out our Stock Option Exit Calculator to see how much your shares could be worth in a future IPO.
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