How does my employer set the stock option strike price?
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Editor’s note: A version of this question originally appeared on Reddit.
I recently received an offer to start as the Head of Product Development at a startup that just closed their seed round of funding. I’ll earn incentive stock options that will make up around 1 percent of the company’s equity when fully vested.
The strike price they’re offering me is valued at around a 20 percent discount to the seed valuation they just raised money at. Is this normal? I usually get offered a 50 percent discount.
- Anonymous
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Dear Anonymous,
Congratulations on the job offer! When you start a new job and are granted stock options, you’ll likely see that the strike price per share and the fair market value (also known as the 409A valuation) of those shares is fairly close.
Here’s why:
Startups are required to perform a 409A valuation at least once a year, and any time there’s a major event that impacts the valuation of the company, like raising a new round of venture capital.
The startup’s board of directors uses the 409A valuation to set the strike price on new stock options that the company grants to employees. For tax reasons, the stock option strike price must be equal to or greater than the company’s 409A valuation on the date that shares are granted.
Your strike price is set on the original grant date, and remains constant, while the 409A valuation changes. When things are going well at the company, the 409A valuation will grow over time.
That could be what you’re describing when you ask about the standard “discount” — by the time you left your previous company, you may have seen the 409A valuation of your stock options grow while your strike price remained the same.
Everything seems to be on track. Of course, everybody’s situation is different, so we’d suggest consulting with your CPA or licensed financial advisor, who can review your stock option paperwork with you.
- Vieje Piauwasdy, Director of Equity Strategy, Secfi
Do you have a question about your stock options? Email us at ask@secfi.com