If you work for a startup that has received a $1bn valuation (a so-called 'unicorn'), you must consider how potential changes in its capital structure will affect your stock option, writes Scott Belsky for Business Insider UK.
Many employees or prospective employees don’t know everything they need to know about the potential long-term value of their stock options, and do not even attempt to find out. “To bring this home, it’s like negotiating your salary without specifying the currency you’re being paid in,” writes Belsky.
Don’t be complacent. Make sure your company’s new financing agreement works for you by asking your company’s CEO these seven questions:
1) Have you agreed liquidations preferences? What are they? Liquidations preferences specify who get paid first, and how much, if a company is sold or goes public. It is standard practice for investors to get paid the amount of their initial investment before employees are paid. But beware of a “high” liquidation preference that specifies that investors get paid more than their initial investment before you are paid. If your CEO has agreed to a high liquidation preference that might affect your compensation, you should consider attempting to negotiate a salary increase or a more attractive stock option.
2) How many months of runway do you have? Runway refers to the amount of time a company can survive before it needs to spend less, make more or raise more capital. If your company is desperate for more runway, your CEO will be more inclined to agree to terms that benefit investors rather than employees, so you should make it your business to know what the plan is.
3) How important is a high valuation to you? These days every startup wants to become a unicorn, but a good CEO will realise that a $1bn plus valuation is not as important as the long-term value of the company’s stock. Ask yourself: is the CEO of my company willing to compromise my shares in exchange for a higher valuation and the sensational headlines that go with it? If the answer is yes, alarm bells should start ringing.
4) Has the company taken on debt? Treat your company’s debt as your debt. If your company is sold, any debt that has been taken on will have to be paid off before the proceeds from the sale can be divided between shareholders.
5) Does the company intend to go public? As a shareholder, you stand to benefit if your company chooses to issue an IPO (Initial Public Offering), i.e. offer its stock for sale on a public stock exchange. Your company choosing to “go public” is likely to increase the value of its stock and is the best way for you to monetise your shares. It is important that you know what your CEO’s intentions are. If he or she intends to keep the company private, you must ask yourself why. Is it part of a sensible long-term plan or is it an attempt to avoid the scrutiny that going public would bring?
6) If the company plans to remain private, can employees and/or founders sell their shares? Your company going public is not the only circumstance in which you can sell your shares. Shares can be sold while a company is still private; this is called a secondary sale. A secondary sale simply means that stock has been purchased from an individual shareholder rather than a company (a primary sale). Be careful when seeking an answer to this question. You don’t want to appear to be too focused on getting rid of your stock.
7) Have the company’s finances been audited? The value of your shares is connected to the financial health of your company. Once a company becomes bigger and more valuable, it should commission a third party to conduct an audit of its finances. This is the only way to be sure that investors are not overvaluing your company.
DON’T WAIT, ASK NOW
Don’t be wowed by the unicorn tag. A $1bn valuation is only something to be celebrated if the mechanics behind that valuation are sound. Ask these questions now; don’t wait until your company is sold to find out how much your shares are likely to be worth or what your opportunities to monetise them might be.
“Your CEO’s willingness to answer these questions, the cleanliness and simplicity of his/her answers, and the assurances your CEO provides you are as important as any quoted value for the shares you are given for your investment of time in the company – an investment far more valuable than money,” writes Belsky.