Negotiating Options with an Internet Start-Up

-by Nancy Friedberg

Before taking that leap to join an Internet start up—confident that soon you'll be a millionaire—it's critical to scrutinize the details. Is the offer really such a good deal? There are important factors to bear in mind as you enter the world of "salary + options."  This is a new area for most of us, so it's important to get to know the territory and the terminology. The accompanying box contains a glossary of important terms; take a look at these before reading further.

 With a grasp of these concepts, you'll be better equipped to ask the right questions and evaluate the offer.

Look for clarity

 1. Knowing the number of options you'll be granted is meaningless, unless you know what percentage of the company your stake represents. So find out the total number of shares outstanding. And knowing the strike price is critical—because you will want to calculate your potential gain.

 2. It is important to know the vesting schedule for your options, particularly if you don't plan to hang around that long or if you suspect that the company will be subject to the turbulence of the dot.com world.  

 You can calculate what percentage of the grant you'll own 6, 12, or 18 months out—or by the time you plan to leave. Many Internet company options vest on a four year cycle, which means that 25% of the options vest one year after the options are granted and the remainder vest over the next three years.

 You should also find out whether you get to keep your vested options when you leave the company. If not, you'll want to plan to exercise the option and buy the shares before you go.

 3. Remember to find out whether the company offers nonqualified or incentive stock options since the two carry different tax ramifications, with the latter being slightly better. It's wise to consult with a financial planner and/or accountant about this.

Negotiation Pointers

 1. Consider the right balance between salary and options. Make sure your salary covers your expenses; options should be viewed as a complement to salary for wealth generation.

 2. Get in early...be one of the first to join the team during the pre-IPO stage. You'll have more leverage because there's more risk for the company. At dot.coms, you can get pre-IPO grants at a cheap strike price, which means, if the company goes public and does well, you may be able to retire early after all.  Know what you can reasonably handle. This is a big consideration because if the company fails the options will be worthless.

 3. To increase your confidence in asking for more options, evaluate the potential of the company by doing your homework. 

  Figure out what round of funding   the company is in.

   Investigate the company's founders  and their track records.

   Research the company's business model and growth rates.

   Study the company's competition in the market and see how it stacks up.

   Know which investors or partners have signed on.

 4.  Find out if there's a restriction on sales of shares by employees.

 If the company remains private, shares held by those who leave often must be sold back at a set price—sale to a third party may require approval and there are restrictions on sales by insiders under federal securities laws and underwriting guidelines. "Whether and when your shares can be resold is an important negotiating point," says Allyn Shepard, an attorney specializing in employment issues for dot.com employees.

Michelle's Success Story

 When Michelle applied for her first Internet job  she had everything going for her—except Internet experience. Still, by following the Five O'Clock Club negotiating methods and leveraging her total background in a seller's market, she was able to get a great deal. (Yes, you can take advantage of the hot job hunter's market.)

 Michelle was hired as part of the management team as Vice President of business development for a high tech start-up. She was able to take advantage of being an "early entrant." Having graduated with an undergraduate degree in engineering from Columbia University and an MBA from MIT, she certainly had the right academic credentials.  Furthermore, she had a record of success with top companies and diverse business experiences. She had been an engineer at a start-up operation at Motorola Company, a strategy consultant at McKinsey and Company, and most recently had done well bringing in new business  as a sales manager at Computer Associates.

 When a new company asked her to come on board, she was originally offered a base of $150,000 and 100,000 options. Michelle had an appetite for risk—and could afford to take a chance—so she "traded up." She asked for a 10% cut in pay and 33% more options; better yet, she also negotiated a 50% discount on the strike price from $15.00 to $7.50, which means she can buy those shares a lot cheaper.

 There are likely to be more interesting scenarios played out in the months and years ahead, since there are no set formulas for negotiating in the dot.com world. So leverage your unique skills, do your homework, be creative and courageous. Good things may be on your horizon. Good luck!