California Dreamin’ — Incentive Stock Options and the Silicon Valley Workerbee

If I had a nickel for everytime I heard the phrase “if we go IPO…”, I could probably buy a nice video game. I have been working in private companies since I graduated college and everywhere I go engineers are dreaming of their companies going IPO and becoming the next Google. I am sorry to be a party pooper but the fact is that very few companies become public, and even if they do it’s very unlikely that rank and file workerbees like me would become fabulously rich. These are the lessons I have learned about stock options and I would like to list the reasons why most people don’t become rich off them.

1. Very Few Shares are Given to Rank and File Employees — The number of shares granted depends on your position and the stage in which you join the company. Logically, the earlier you join and the higher you are in the orgchart mean you would be given more shares. One important question a lot of young employees do not ask is how many shares are outstanding. Mathematically, 10000 shares out of 100 million shares is a lot worse than 10000 shares out of 1 million shares. The most I have been granted was 6000 out of 11 million. So even if I had all 6000 shares and they rose to $50 a share I would have about $150000 after taxes. That is not a very large amount to last for life. Another fact is that it’s pretty unlikely for a small private firm to go public and get $50 a share.

2. There is a Vesting Period — The standard vesting schedule for incentive stock options is as follows. 25% of your options vest after one year of service, and the rest vest in 3 to 4 years depending on the company. The most common plan I have seen is that 1/48th of the options vest every month after the first year so it takes a total of 4 years to receive all your shares. This is why a lot of people did not manage to cash out in the dot com boom. I have heard many stories of senior engineers who had options worth millions that they couldn’t exercise because they haven’t served a year yet. The market then collapsed so fast that their paper wealth became truly worthless.

3. There Are Often Preferred Shares — If you do receive employee stock options they are probably options for common shares. There is another class of shares called preferred shares that may be owned by the venture capitalists and other early investors. What preferred shares mean is that these shares need to be paid first in case of an exit event. An exit event is either a sale or an IPO. Most small companies are merged and sold to bigger entities before they ever go to the route of an IPO. In the case of Epinions, the employees who held common share options were royally screwed when they merged with DealTime to create Shopping.com. The reason is that Epinion’s preferred shares’ holders were promised a payment of 45 million dollars but the merger only yielded 30 million. That means all common shares were rendered worthless. Shopping.com then went on to a successful IPO and then it was subsequently purchased by Ebay, but the original Epinions employees got nothing.

Are there people who get ridiculously wealthy from stock options? Yes, but they are either incredibly lucky or they are very high up in the organization so they have a lot of shares. I don’t really count on my luck, and right now I am just a tiny pawn in the corporate jungle. The most important thing I have learned in this crazy place is to never count the money before it’s in your bank account. I have heard stories of people who bought extremely expensive homes during the dot.com boom because they were paper millionaires. That is a very bad idea.

Despite my knowledge of my dismal chance of ever becoming rich with my stock options, I still dream sometimes with my coworkers. Today my coworker said, “if we go IPO, I’d go shop at Santana Row instead of Gilroy outlet!”. I think that’s a reasonable aspiration. Since all three companies I have served are all going strong I hope someday I can afford a nice vacation with the sale of my shares.

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