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This page contains all of the posts and discussion on MemeStreams referencing the following web page: Startup Stock Options: Should you Exercise your Options? - Dave Naffziger’s Blog. You can find discussions on MemeStreams as you surf the web, even if you aren't a MemeStreams member, using the Threads Bookmarklet.

Startup Stock Options: Should you Exercise your Options? - Dave Naffziger’s Blog
by Lost at 8:22 pm EST, Nov 13, 2007

Here is a super-simplified timeline / decision hierarchy:

1. Investors decide if they should convert their preferred shares to common.
2. Common stock holders decide if they should exercise their options.
3. The proceeds are first distributed to the preferred shareholders up to their liquidation preferences. For example, if they invested $5M with a 2x liquidation preference, the preferred shareholders would receive the first $10M of any liquidation if they chose not to convert to common stock.
4. The remaining proceeds are then distributed ratably to the common shareholders (unless the preferred stock is ‘participating preferred’. In this case, the preferred share holders are treated ratably like the common shareholders).

Simplified, investors typically get their money first and common shareholders (you) get paid based on what’s left.

There are several questions that you’ll need to address to help guide your decision:

* What % of the company do my options represent? If you don’t already know the number of authorized shares, find out. Your percentage of ownership is determined by dividing your options by the number of authorized shares (Keep in mind that ‘authorized’ is substantially different from ‘issued’ or ‘outstanding’ shares).
* What do the investor preferences look like? If your company has taken multiple rounds of financing, this can be very hard to answer. Management should be able/willing to tell you two numbers:
o The exit value where common stockholders get nothing, and
o The exit value that would trigger the preferred shareholders to convert their preferred stock to common stock.
* Can I expect further dilution? (Will the company need to raise more money). If the company will need to raise more capital, dilution will be forthcoming. If the company has lost momentum (or did a very expensive prior round), and needs to raise more capital, expect lots of dilution.

Gauging Future Dilution is hard. Whenever a company raises money, the capitalization table can be entirely renegotiated. This rarely happens at a company with strong momentum that is raising money had a higher valuation than the prior round.

If a company is struggling, the capitalization table can be completely changed. The new investors have tremendous leverage (presumably because others don’t want to invest) and may value the company at a very low amount, effectively washing out prior shareholders. They’ll want to make sure current employees are appropriately incentivized, but former employees are at the bottom of their priority list.

I find it useful to generate several scenarios to see what my financial outcome would look like if the company had an exit. You’ll have to make some assessment of the likelihood of those scenarios and hopefully you’ll at least have enough data to figure out if it makes sense to exercise your options.

A lot of people get excited about their options without doing this analysis or having any of the relevant facts. And they never get a dime for their options, that they paid for.


 
 
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