How to compute worth of my equity?

Question

I am a newly appointed consultant to a startup. I work in another organization which forbids me to receive any salary for being a consultant. However, I am allowed to have an equity.

The startup management has provided following equity to me in the contract that I am yet to sign:

• Total number of Options: 100,000 Ordinary Shares
• Exercise price: $0.00001 per Ordinary Share.
• Vesting period: All Options are to vest progressively on a monthly basis over a 3-year period with a 3-month cliff period.

This terminology is new to me. How do I compute the total worth of my equity? It seems like I hold only $1 because 100000*$0.00001 = $1. What is meant by the vesting and cliff periods?

Any basic explanation will be greatly appreciated.

Answer 1

It seems like I hold only $1 because 100,000*$0.00001 = $1.

No - you have the right to buy stock at $0.00001 per share. Presumably, the stock will be worth more than that, so your "profit" will be the value of the stock that you essentially get "for free".

What is meant by the vesting and cliff periods?

Every month you are "vested" (entitled to) an additional 1/36 of the amount of stock you have options for (100,000 shares, or about 2,778 shares per month). If, however, you leave (voluntarily or involuntarily) within the first 3 months, you get nothing.

How do I compute the total worth of my equity?

Unless the company goes public and your shares are converted, there's not really a good way to determine the value of a share. They're worth whatever someone is willing to pay you for them. Since there's not a public market, you're at the mercy of whoever is willing to buy them from you.

To get even a rough estimate, you'd have to know 1) how many shares are outstanding (100,000 sounds like a lot unless there are 1 Billion shares outstanding, in which case you own 0.01% of the company) and 2) the value of the company, which may mean at a minimum the market value of all assets, or the present value of future cash flows (which is a much more complicated discussion).

So you are essentially taking a risk that you might be working for free (if the equity ends up worthless) or you might be rich if the company takes off.

Answer 2

Cliff period is defined as that period until you vest any options. So if your employment is ended at 2 months 29 days, then you would have zero vested options. Waiting one more day gives you 8.33% of your options, or 8,333. Each month thereafter about 2778 options vest.

Your base price is essentially zero, or just a fraction of a cent.

To determine your equity you must know what you can exercise the options for. For example if you could exercise those options at 100, you would receive the difference between your base price and that exercise price. With 100k shares fully vested, you only need a price of about $14 to become an instant millionaire after taxes.

However, from what it sounds like, your equity is currently zero. There is no market for the company now and if it fails, it will remain so. However the lure of such propositions is that you can become wealthy very fast.

At this point I would not value these options as worth anything. Even once a company starts acquiring customers then can still fail. I can speak from experience, I had both a private company fail despite having a good customer base; and, a public company that I worked for awarded me options that were worthless. In the later case the strike or base price was higher than the prevailing stock price.

Answer 3

First of all, these are pretty much options in name only: unless the company goes bankrupt (in which case, "options" and "shares" would be equally worthless), the price per share is going to more than $0.00001.

The vesting period is how long until you can actually use the options. You have a 36-month vesting period, so every month, you'll earn slightly less than 3k options. The cliff means that the options you earn during that period won't vest until right after the cliff point. In this case, after the three months, 8333 options (three months' worth) will vest.

The $1 isn't the worth of the options, it's how much you have to pay to use them. It's clearly just a nominal amount to make this technically an option rather than shares.

Normally, the value of an option depends on more than just the share price, but in this case the strike price is so low that you can treat them as being the same. If your company is publicly traded, then you can just look at the stock price. But "start up" implies that it's not. So the best approximation would be looking at how much money has been put in it. Look at funding rounds, if information about them is available: how much was raised, and for what percentage of equity? Dividing the former by the latter gives the market capitalization. If you know (or can estimate) what equity other people have gotten, you can treat that as funding (they are "buying" the shares with their labor).

Note, however, that venture capitalists are fund start-ups based largely on what they think their future value, discounted by their beta, is. Beta is a measure of risk, but is how much risk an investment adds to a diversified portfolio, and is lower than the investment by itself has. So if the value of this equity makes up a large portion of your holding, this means you're not well-diversified, and thus you should discount by a rate higher than beta.