Why can a startup option grant be worth far less than the headline value quoted with the offer?

## The failure this question exists to prevent A candidate is told the option grant is "worth" a large sum. The arithmetic behind that sentence is nearly always *share count times the price paid in the most recent investor round*. That single multiplication contains three separate errors, and correcting them is the whole skill. ## Error one: preferred price is not common price Investors typically buy **preferred stock**, which carries rights that employee **common stock** does not. The most consequential is a **liquidation preference**: in a sale, preferred holders are commonly entitled to get their money back (sometimes a multiple of it) before common holders receive anything. Pricing common shares at the preferred price therefore prices them as if they carried rights they do not have. This is also why the strike price on an employee option is normally far below the preferred round price. In United States private companies, the strike is typically set against a board-approved independent valuation of the common stock — often referred to there as a 409A valuation. The mechanism, its name and its legal basis vary by country, so treat it as the shape of the thing rather than a universal rule: an independent valuation of common stock, deliberately lower than the price investors paid for preferred. ## Error two: the strike is money you must pay An option's value is the **spread** — share value minus strike — not the share value. If a grant covers a number of shares and the strike is a meaningful fraction of the current common value, a large part of the headline is money you would have to hand over to realise it. And exercising is a real cash outlay, made before there is anything to sell in most private companies. ## Error three: percentages shrink Every financing round issues new shares, so an existing holding represents a smaller slice of a larger company afterwards. This is **dilution**, and it is not a wrong done to you — the point of the round is to make the whole worth more — but it means today's percentage is not tomorrow's. As an illustration with invented figures: a grant that represents 0.42% of the fully diluted shares at signing might sit closer to 0.29% after two further rounds. Those numbers are made up to show the direction and magnitude of the effect, not a forecast for any real company. ## What to ask instead, and of whom The compensation partner who issued the written offer can answer most of this, and a company comfortable with employee ownership will. Work from the grant's vesting table and add the missing facts to it: - How many shares is the grant, and how many shares are outstanding on a **fully diluted** basis? Without the denominator, a share count means nothing. - What is the strike price, and what valuation of the common stock was it set against? - What is the preference stack — how much investor money sits ahead of common in a sale? - What happens to vested options if I leave, and how long do I have to exercise? The last of those is worth marking on the table beside the cliff row, because it decides whether the grant survives your departure at all. ## Turning the answers into a view Once you have the percentage of fully diluted shares, the strike and the preference stack, do the arithmetic in scenarios rather than in a single number: what does the grant return if the company sells for roughly what investors have already put in, for a few times that, and for a great deal more than that? At the low end, preferences often mean common holders receive very little; the grant only becomes meaningful well above the money already invested. Seeing that shape is more useful than any single valuation, and it is a conversation a compensation partner can hold without disclosing anything confidential. It also reframes the negotiation. If the equity is genuinely uncertain, the cash components of the offer are carrying more weight than the headline suggests — which is a legitimate thing to say out loud. ## The honest counterweight None of this means startup equity is worthless. A low strike set against a low common valuation is exactly what makes early equity valuable when things go well, and dilution accompanies growth that raises the value of the whole. The point is not pessimism, it is that a defensible view requires the percentage, the strike and the preference stack, and the headline figure contains none of them. ## Anti-patterns Accepting the preferred-round multiplication as a valuation is the central one. Its relatives: quoting a share count with no denominator, forgetting that exercising costs cash, and treating a percentage as fixed for the life of the grant.