What is the best way to evaluate the value of stock options for a pre-IPO company?

Chris Barsness, startup, finance, law, and tech nerd

Most importantly, you need to understand your own tax consequences when looking into forms of compensation instead of straight cash/salary and what type of options, e.g. ISO.  However, if you are just concerned with giving an idea to what options might be worth to you, the main aspects relate to company capitalization and valuation.

The employer may not understand why you care and may not give you the information (if you actually own shares, you might have the right to inspect their books as a shareholder and find out some of this info), but here are some items to look at:

1)  Total capitalization of the company-  How much in terms of stock has already been issued and how much is reserved (authorized) for future issuance?

2)  Stock option plan-  Is there a stock option plan in place?  If so, where is the company at under the plan, i.e. how many options were reserved and allowed to be issued to employees and how many have already been given out?

3) Company valuation-  What is the company worth?  This can be what the current stock is valued at per share or what the entire company valuation is.  If the company recently raised money, there would have been a “post-money” valuation which would be of interest to you.  If a founder or executive says the company is worth $50 million or they are a $50 million company, that is probably what that person is referring to.  If the current valuation is $50 million and the company has 1,000,000 shares of stock issued and outstanding, that is essentially a $50 per share valuation.  The fully diluted valuation may be different because you look at the effect from any options being exercised.  If this same company has granted options to purchase 1,000,000 shares of stock and we assume everyone exercise them, the company could potentially have 2,000,000 shares of stock and the price per share drops to $25 per share (still a $50 million valuation).

Here is a link to my discussion of things to look at in terms of options and valuation and how to do so:

http://siliconvalleystartupattor…

Basically, you want to know how much the company is worth and number of outstanding shares to know how to value the option.  If you are dealing with a startup, you can try to compare your company to others in similar industries to get a valuation or go based upon recent rounds of funding and those valuations.  Also factoring in a discount to that value for the fact of the risk of failure for the company and whether you will be able to sell the stock and when.  There are securities laws that prohibit transfers of stock except under certain circumstances until the company is fully reporting (public/IPO).

At the end of the day, there is no clear cut formula, but if you estimate the value per share less exercise price times number of shares, you come up with a basic value.

See question on Quora

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