Stock Options are like lottery tickets?

https://hunterwalk.com/2024/05/11/are-startup-stock-options-like-lottery-tickets-a-ceo-and-former-employee-discuss-and-my-pov/

by hunterwalk • 2 years ago

19 25 2 years ago

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JumpCrisscross6• 2 years ago

Yes, from the employee’s perspective in early-stage start-ups; no the rest of the time.

For an early-stage start-up employee, a stock option is akin to a lottery ticket in that its value is binary (lots or zero). For a late-stage start-up, the distribution is less binary, so I’d liken it to several rounds at an unbiased casino more than a lottery ticket. For a public company or private company with liquid stock, no. Those options are straight-up compensation with a variable component.

Systemically, employee stock options are totally unlike lotteries in that they’re part of a positive-sum system.

toomuchtodo3• 2 years ago

Where do you delineate between early and late stage? Series A?

Edit: Thank you!

JumpCrisscross6• 2 years ago

Where do you delineate between early and late stage? Series A?

Conventionally, it’s around Series C, though anyone who’s worth more than $1bn counts in my book.

For purposes of this discussion, the annual failure probability for American businesses seems to drop below 5% around the fourth year [1]. At that point, if your options aren’t underwater, it’s fair to consider them to be less like lottery tickets. (I couldn’t find failure probabilities by VC round or capital raised, so this is probably conservative inasmuch as small businesses fail at a higher rate than venture-backed companies.)

[1] https://www.bls.gov/bdm/us_age_naics_00_table7.txt

metadat2• 2 years ago

As an employee, the options are generally worse than a lottery ticket, because the terms of ownership % can be changed later in closed board meetings, then you're screwed.

Very few success stories for early non-founder employees making a big payday. You can do okay, but on average it's not better than getting Meta RSUs or equivalent.

JumpCrisscross6• 2 years ago

options are generally worse than a lottery ticket, because the terms of ownership % can be changed later in closed board meetings, then you're screwed

This is demonstrably false given there is a market value for common stock in private companies, even early ones, whereas few people would pay face value for a secondhand lottery ticket (even assuming zero risk of scam).

alephnerd3• 2 years ago

You can do okay, but on average it's not better than getting Meta RSUs or equivalent

Most people aren't getting hired by Meta, and compensation packages at late stage companies will try to be competitive with peers.

That said, late stage options might not always be a good bet. You as an employee need to do due diligence and ensure their meeting their metrics.

foobarkey2• 2 years ago

I think there is a sweet spot between risk and expected value, ideally earlier before the IPO looks like an obvious next step. Won’t be retirement levels of money in one go but I would say it is more like 80/20 (success/failure) in that case.

Gambling is only bad thing if the odds are not in your favor.

boshalfoshal• 2 years ago

The thing is, at that point going to a larger public company would probably net you similar returns and less of the headache (immediately liquid compensation that you can invest into other things, no tail risk of option value suddenly becoming 0, likely better wlb, etc).

Once it an "obvious" choice to join a startup then the valuation of the company is already close to fair, assuming you have about the same edge as VCs do when evaluating these companies. On IPO day it may jump up a bit from its last posted private valuation, but keep in mind once the company IPOs you're typically subjected to a 1-year lockup period, during which the value of the company could change drastically.

foobarkey2• 2 years ago

No, the company is hopefully in high growth stage at that point so ideally you want to join at x and get to IPO at 5x+ (or more) in 4 years. It’s sort of a combination of investing in low cap stocks and swing trading at the same.

Getting the train moving is the hard part but when it is already going it’s about not screwing up and execution, many times better odds (of course evaluate it like you would evaluate stock before buying)

The number of X-s for large cap RSU-s are less likely to be amazing so joining those RSU-s should be pretty much considered at face value (or maybe 10% YoY)

tedunangst• 2 years ago

More like tickets to the ring toss.

blackeyeblitzar3• 2 years ago

I definitely agree that options are not worth much at pre public companies, unless it is a very obvious case of a runaway success (like OpenAI or whatever). It’s not just that the valuations can be misleading (look at 2021 peak valuations), but also that the company’s leadership (CEO and board) can do all kinds of things that affects the employee’s actual value in those options without any transparency or input from employees. Like they could issue many options and dilute existing owners. They could take on new funding with bad terms like liquidation preferences or whatever. They can choose whether to provide liquidity (through an IPO or secondary) or just stay private for as long as they want. They can choose to expire your options after you leave. The fine print in the agreements that come with most offers of employment and stock option grants give those companies lots of freedom and give employees almost nothing.

It’s not just that the chance of success for a startup is low. That alone would make it a lottery ticket. But it’s also that you have to rely on trusting a small group of people that are usually not at all transparent and usually not deserving of trust either. They can screw you over even if the company is successful - which is exactly what happened in many prominent cases like Skype’s acquisition. This needs to change, and the reason it hasn’t is because employees who don’t know any better keep agreeing to work at these companies under abusive terms. Instead, they should start rejecting these companies until the norm is to have fair employee-friendly terms and total transparency around the cap tables, investor agreements, etc.

advisedwang• 2 years ago

To value stock options correctly you must know a lot more than the headline valuation. You have to know the size (in $ and units), preference and other terms of every funding round, burn rate, cash left, whether any one investor has outsize control of the company and finally a good view of the competition, market and potential buyers. This is not available to the average employee, and often not to founders.

Stock options are a gamble not because of the economics of startups (although that can be true), but because the average employee cannot do serious financial decision making around them.

sigmoid10• 2 years ago

The key difference is that diversification of risk works for stocks. Yeah, if you invest in just one company it's like going to a casino. So if your portfolio only includes stocks from your employer, you might as well gamble all your money. But when you invest in lots of different stocks, you can make pretty stable profits, whereas you'll never make any stable long term income by diversifying your bets in a casino.

Stock Options are like lottery tickets?

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