Evaluating Stock Options and Start-ups in the Med-Tech Sector

So, you heard about a guy you used to work with who “hit it big” on a medical start-up, and you are wondering how he got so lucky. More importantly, you are curious how can you do the same thing?  

Unfortunately, there is an abundance of misinformation out there about startups and stock options. Equity can be a huge incentive for joining a startup early but knowing how options work and the potential value can be confusing.  

In truth, most medical sales reps I work with do not fully understand stock options, even when they are presented with an offer that includes equity. Some reps are under the false impression that stock options are “free money” or a quick path to retirement. As Lee Corso might say…"Not so fast, my friend”.

Let’s review some basic questions/answers of a typical stock options “package” that is commonly offered with start-ups. Most equity offers within the med-tech sector are fairly standard and tend to follow the same formula. Disclaimer: This is simplified illustration of what is normal in the industry, but there are always going to be outliers.  

What is a Stock Option (ISO)?

A stock option is a contract that gives you the right to buy a stock at an agreed-upon price. The price at which you can purchase the stock is called the strike price. If your employer grants you 10,000 options, you DO NOT own 10,000 shares. Rather, you have the option to buy 10,000 shares at a preset strike price. Doing so is called exercising your option.

• Example 1: CrossVine Medical grants Michelle 10,000 ISOs with a strike price of $1 per share. Five years later, the company goes public and is now trading at $10 per share. If she exercises all of her 10,000 options, she’d make a profit of $90,000 ($10 *10,000 - $1 * 10,000)
• Example 2: CrossVine Medical grants Jim 10,000 ISOs with a strike price of $1 per share. Five years later, the company has gone public, but is now trading at .50 cents per share. Because Jim’s strike price is higher than the market price, his options are worthless. Logically, Jim will not exercise his options but he DOES NOT lose any money.

How quickly can I “cash in” on my options?

First things first, no company is giving away free money the day you get hired. Stock options have a vesting scheduled. A typical vesting schedule is four years with a one-year cliff (See Illustration).

This means that if you leave the company within your first year, you walk away with ZERO. If you stay, 25% of your shares will vest on your one-year anniversary, the remaining 75% of your shares will vest monthly over the next 3 years. At 4 years, all of these options will be fully vested.

My offer letter includes 30,000 options, but the strike price isn't listed… Why?

Stock options grants are based on timing and precise accounting principles, which is why they require approval by the board of directors.  It is very rare for a middle manager or HR personnel to be able to put an exact number in writing in an offer letter (thus price ranges are often used). The exact strike price is disclosed after board approval.

When can I convert my options into cash?

Options can be converted into cash when your company experiences a liquidity event…like going public (IPO) or being acquired by another company. If your company is acquired, your options may get converted into cash or they might be converted into options in the purchasing company (depending on the terms of the acquisition).  Some start-ups have “accelerator clauses" which allow options to become fully vested when an acquisition is finalized.  

What happens if I leave my company?

If you leave your job, you typically have 90 days to exercise your options. Once those 90 days are up, you forfeit all your options.  

Do I have to come up with money to buy my options when the times comes to exercise.  

Exercising options is often a “cash-free” transaction.  I have heard people confusingly say things like “I couldn’t buy my options because I didn’t have any extra money”.  This is erroneous logic as you are buying and selling simultaneously; and simply subtracting your costs from the proceeds of the sale.

So what are my options really worth?

Trying to establish a value for stock options (Pre-IPO) is impossible unless you have a crystal ball that tells the future.  If the recruiter or the hiring manager starts spitting out impressive dollar figures, please realize that this is nothing more than a guess (or wishful thinking).  

MY RULE OF THUMB...If you believe in the company leadership and the technology enough to change jobs then you should believe that the stock options will eventually be valuable. Changing careers solely based on stock options in not advisable, but they should not be ignored. The stock options should be viewed as Icing On The Cake.

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