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Stock Options

February 5th, 2016
money, stock

When I was joining Adverplex (now CogoLabs) in 2010 they offered me a combination of salary and stock options. After I decided I should be risk-neutral with donation money I decided to ask for less salary in exchange for more stock. How did this work out?

Not so well. Overall I lost ~$12k in salary and ~$2k in stock, and the outcome was one I hadn't even considered in trying to figure out how to value the options.

When I was considering asking for less salary in exchange for more options I needed to decide on a valuation for the stock options so I could compare them. The CTO had told me his "target valuation is $1B," his "personal guess is $500M," and he "would be surprised if it did not come out to at least $100M". I drew up a table of possible company valuations:

  10%:  company fails, options worthless
   5%:  company sells for ~50M
  10%:  company sells for ~100M
  15%:  company sells for ~250M
  25%:  company sells for ~500M
  20%:  company sells for ~750M
  15%:  company sells for ~1B

   EV: $498M

This seemed too optimistic, so I pulled it down to:

  50%:  company fails, options worthless
   5%:  company sells for ~50M
  10%:  company sells for ~100M
  25%:  company sells for 100M-500M
  10%:  company sells for ~1B

   EV: $175M

I sent this to some friends, they convinced me this was still too optimistic, so I updated down again:

  34%:  company fails, options worthless
  10%:  company doesn't grow, options worthless
  10%:  company sells for ~$25M
  25%:  company sells for ~$50M
  15%:  company sells for ~$100M
   5%:  company sells for ~$300M
   1%:  company sells for ~$1B

   EV: $55M
I went back to the company, we negotiated back and forth, and I agreed to give up $7k/year for options I valued risk-neutrally at $9k/year. (Options for an additional 1/6,400th of the company annually.)

I started at the company, things were good, but several years later I decided to leave for Google. I had vested options for 0.06% of the company, and I had a choice: I could exercise, paying the strike price of $2,820 to turn the options into stock, or I could give up the options. My estimate of the company's valuation had gone up since I had done the initial calculation, so I decided to exercise.

Over the years I watched the company as it grew its business and brought on more employees. A small project I had worked on the beginnings of grew into a company big enough to move across the street, and the main company outgrew the area I remembered, expanding into an additional 10k sqft on the floor above. It looked like the company was doing well, and I was content to wait until it went public, was acquired, or folded.

I was surprised, however, when they sent me a letter that they were doing a reverse stock split, 90k:1. This means that for every 90,000 old shares you had, you would get one new one. They weren't allowing fractional shares, and I had far less than 90k, which meant I was forced to sell. Worse, their current valuation (~1.2M) was lower than it was when my shares were issued (~4.7M), which meant that after paying $2,820 to exercise I would be getting back just $734.

So, what went wrong? Now, I knew this was a risky option, and something I was only willing to do because I was being risk neutral, but the way it ended up not working out wasn't actually something I had considered. Looking back over the emails I sent to friends at the time asking advice, here's what I would do differently in the future when evaluating options. Not all of these are things that went wrong in this case, but knowing more they're things I would take into account:

I feel pretty bad about this, all in all. I gave up thousands of dollars in passed up salary and exercising options, and if I had gone with salary instead that would have been money that could have done a lot of good via an effective charity.

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