Do pre-IPO stock options count toward my net worth?
Employee stock options and net worth
Editor’s note: A version of this question originally appeared on Reddit.
I joined an early-stage startup about a year ago, and got stock options that vest over the next four years. Since I joined, the private valuation of the company has increased significantly from my strike price — if all of my stock options vested immediately, they’d be worth around $400,000 today.
I’m curious how other people factor stock options into calculations of their net worth. Obviously, stock options are worthless until the company goes public or gets acquired.
How much can I expect to receive in the future if I stick with the company and it goes public or gets acquired? I could easily see the company’s value growing by 10x in the next few years.
How should I expect to see the value of my stock options change over time? Will it increase as the company valuation increases? Will it decrease due to dilution? I don’t know if an IPO would mean a nice bonus for me, or an instant ticket to retirement.
- Anonymous
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Dear Anonymous,
Congratulations on joining a fast-growing startup that you’re excited and optimistic about! There’s nothing better than loving the company you’re at, and wanting to invest in its future success.
You’ve got a bunch of individual questions peppered throughout your note, so I’ll do my best to answer them individually.
First, one of the first things that every startup employee earning stock options should do is build a plan for your stock options now. Depending on the type of stock options you’re earning (Incentive stock options? Non-qualified stock options? Restricted stock units?) you should know when, how, and if you plan to exercise them, and how much that will cost.
For example, let’s say you joined your startup last year and were granted 200,000 incentive stock options that had a strike price of $1 per share. Several months later, the company raised a big round of funding, their valuation doubled, and your shares are now valued at $400,000.
When it’s time to exercise your stock, you might be surprised to find you owe taxes on the difference between your cost basis ($200,000, hypothetically) and their current valuation ($?). If you think the company’s value might grow 10x in the next couple of years, your tax bill could potentially grow to more than $1 million in the future.
That’s why it’s a good idea to start making a plan now. Exercising options is making an investment in the company you’re helping to build. And, like any investment, there are risks. If it fails, you could lose that investment. If you wait, your cost to exercise could be much higher — potentially too much for you to afford — and could result in you taking home less gains when the company exits.
Second, one correction: You don’t necessarily need to wait for an exit event (IPO or acquisition) to sell your shares. Pre-IPO secondary markets exist, where startup employees sell their pre-IPO shares to investors at a discount. Additionally, some startups offer early employees opportunities to sell their shares to investors, or back to the company itself. Just be aware that doing this would mean that you lose any future value if the company continues to grow, gets acquired, or IPOs.
OK! On to your questions:
“I’m curious how other people factor stock options into calculations of their net worth.”
There’s no one-size-fits-all answer here — as far as I’m concerned, if you’ve exercised them, you should value stock options like any other investment, albeit one that has higher-than-average risks and very likely doesn’t have a liquid market yet.
“How much can I expect to receive in the future if I stick with the company and it goes public or gets acquired?”
Again, there’s no average answer here — you could very well see the company’s value grow by 10x between now and its exit, it really depends on the company and when you joined. Again, it’s important to remember that there is still a risk that the company could fail.
“How should I expect to see the value of my stock options change over time? Will it increase as the company valuation increases? Will it decrease due to dilution?”
If your company is growing rapidly and is on a good trajectory, you should expect to see its valuation grow over time. Startups that issue stock options regularly perform 409A valuations (also known as fair market value), where a third-party valuation firm estimates how much the startup’s shares are worth.
Virtually all startup employees experience dilution as their company raises new rounds of funding. That’s not necessarily a bad thing — would you rather own 50 percent of a 1-pound pie, or 1 percent of a 100-pound pie? In this example, although you experienced pie “dilution,” you ended up with a larger absolute value of pie.
“I don’t know if an IPO would mean a nice bonus for me, or an instant ticket to retirement.”
Startup employees hope that their stock options will supercharge their journey to financial independence. The first step is building a plan for your stock options.
At Secfi, we believe you should consider your equity as part of your full financial picture, and our Portfolio gives you that view.
- Vieje Piauwasdy, Senior Director of Equity Strategy, Secfi
Do you have a question about your stock options? Email us at ask@secfi.com