Options are a work of genius, one of the roots of Silicon Valley’s extraordinarily innovative productivity. They allow cash-strapped startups to reduce their cash burn, and people granted options to share in the Company’s upside.
But they have their limits.
The principle behind them is that all participants in a risky startup should share in its economic growth, especially those who forego good salaries and benefits in established industries. Investors share automatically because their shares increase in value if their startup is a success. Options enable employees and consultants, even Board and Advisory Board members, to share too.
The “value” in a stock option is measured by the difference between the exercise price on the date of grant (option grants are made by the Board or its delegate) and the value of a share when it is exercised.
That value is normally only realizable when the company is sold or makes its IPO. The Option Plan, a part of the required documentation, clarifies what happens when the Startup is acquired. That is the key part of the deal from the grantee’s perspective.
http://firstround.com/review/The-Right-Way-to-Grant-Equity-to-Your-Employees/ This is a great summary of the value of option plans and how to use them. Andy Rachleff, who wrote it, is President and CEO of Wealthfront, a software-based financial advisor, and teaches courses on technology entrepreneurship at Stanford Graduate School of Business. As a Cal alumnus, I forgive him because he points out how more option grants, judiciously structured, are better for investors than less. Not enough people in the right places grasp this.
Here’s Mashable’s useful quick summary of some of the issues and terms used in startup options: http://mashable.com/2011/09/29/startup-stock-options/#qYSq6gn5OZqw
Finally, a law firm which specializes in options from published this very useful blog post directed principally at startup employees and others looking for guidance on what to expect. http://stockoptioncounsel.com/blog/joining-an-early-stage-startup-negotiateyour-equity-wisely-with-stock-option-counsel-tips/2014/2/12. Mary Russell, who wrote this post, started her legal career at WSGR in Palo Alto (a great place to learn startup law!), and applies her company-side experience there to her stock option legal services for individuals.