Questions

How do you calculate the value of stock for a start up consulting company for the purpose of stock options?

The company is profitable, but the revenue is closely tied to the celebrity of the founder. If he wasn't involved, the company would be unremarkable, so I'm not sure it would even be possible to sell it. How do you place a value on stock options in a situation like that?

3answers

There are three questions here:
- the strike price of the options
- the market value of the company
- how much those options are actually worth to the recipient

1. The strike price is the price people pay to exchange their options for shares. You can set any strike price you like: it's just a negotiable contract term. However, if the strike price is less than the market value of the shares, the options are taxable (which people tend to avoid), so you typically set the strike price at or above the market value.

2. The market value of the company is how much the company is worth. The celebrity of the founder is clearly a big part of it. If the company were sold, the acquirer would want the founder to lock in as part of the acquisition. So figure out the value a couple of ways:
(1) off standard profitability metrics: X times yearly profit and/or revenue vs. comparable companies
(2) off the acquisition price: with and without the founder and add the percentage chance the founder would go with it
(3) off recent transactions in the stock (what people pay for the stock is a great indicator of value)
These will give three different answers: pick some sort of average number, so you can justify your strike price.

3. What the options are worth to the recipient: remember they are only worth something if the recipient can exercise them for stock, and then sell the stock (or receive dividends) for more than the option's strike price. So figure out the probability of the company being sold above the strike price in the next X years, and what an weighted average expected sale price is for the company in the next few years (noting the founder's importance), and that's what the options are worth.

I hope that helps.


Answered 6 years ago

There's no hard and fast answer for this one, since it is really hard to determine the true value of a startup company in its earliest stages.

Still, you have to do something, so here's some gory detail. One approach is to assume that you might raise $250k for 25% of the company in its earliest stages. Let's assume there are 1m common shares or equivalents (things that can convert into common shares) after this investment. Then each such share might be worth $1. However, likely, the investor's money carries a more senior liquidation preference than common shares, so some kind of discounting factor must be applied to get the true value of the common shares. You can pick whatever you want, unfortunately. I pick 90% discount, meaning that the commons are worth 1/10 of whatever the investor paid per share. In a company with virtually no assets and no (or little) profit, this is a defensible position).

So, this means that the current value of your common stock is $0.10, and therefore a "fair market value" strike price for your stock options is also $0.10 per share.

"But I haven't raised any money yet!". This doesn't really matter. You project forward to the point where you raise money, and then calculate backward to get a current value per common share.

Bottom line: In a new startup with somewhere close to a million shares issued or expected to be issued, $0.10/sh is a value that should not raise too many eyebrows. It's as good as any other number, and is workable from the perspective of getting your employees on board with proper stock option paperwork. If you raise a large amount of money later on and suddenly find yourself with 10 million shares, you may need to issue more stock options, but that's easy to do.

Dan


Answered 5 years ago

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