“Wait, I have to buy my equity?”
Stock options are confusing, which is why many employees see it as Monopoly money.
Even the concept of strike prices can be completely foreign for the first time grantee.
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So a hotly debated topic is how much should I talk about the “spread” between share prices and strike prices?
In other words, should I be communicating net equity value or gross equity value?
The short answer is both.
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But it’s not that straight forward.
So let’s start with some basic definitions (and math).
What is Gross Equity Value?
Gross Equity Value is the total value of your shares based on the most recent preferred share price, regardless of how much it’d cost you to exercise your options.
It’s calculated as:
Where:
- # Shares = The total number of options in the grant
- Share Price = The preferred share price in the most recent round of financing
Quick “Gotcha” Note: Many teams confuse share price with “Fair Market Value.” The preferred price is typically not the “Fair Market Value” or “FMV.” The FMV refers to the strike price, which doesn’t come into play for gross equity value.
But the problem is this isn’t the most accurate representation of the equity grant because it doesn’t take into account the cost to exercise the options.
Which is where net equity value comes in.
What is Net Equity Value?
Net Equity Value takes into account the “spread” between the share price and the strike price.
In other words, if you were to exercise your options, then sell them at the most recent preferred price, how much would you have left in your pocket?
It’s calculated as:
Where:
- # Shares = The total number of options in the grant
- Share Price = The preferred share price in the most recent round of financing
- Strike Price (or Fair Market Value) = The cost to exercise an option as determined by a 409(a) valuation.
But net equity value isn’t fool proof!
There are quite a few nuances that are critical to communicate to ensure you (a) set crystal clear expectations with employees and candidates and (b) avoid opening yourself up for liability.
For instance, strike prices are subject to change. Every option grant can be board approved, and if a material event (e.g. a fundraising) occurs during the hiring process, the strike price could go up.
As companies approach an IPO, many will even opt for quarterly valuations––meaning the strike price will constantly be a moving target.
In these cases, many late stage teams won’t even break out the difference between the share price and strike price.
They’ll just communicate net grant value and say “regardless of the strike price, this will be your net grant value.”
What should I do?
It’s all about your level of comfort and transparency as a company.
Most companies we find communicate both Net and Gross Grant Value, given that options don’t come for free.
What’s critical is that you enable any manager, recruiter, or HRBP to talk about equity in a way where they can clearly break down the moving variables that make up someone’s net grant value.
Having one team speak in gross and another speak in net can be a quick recipe for disaster.
Of course, always work with legal counsel to craft an equity narrative that ensures you’re communicating compensation in a way that’s accurate and avoids excess liability.
And at Pave, we help you ensure everyone has a crystal clear understanding of what their equity is worth.
From your offers to your total rewards statements, we visually break down equity so everyone, from recruiters to candidates and employees to HRBPs, are on the same page.
Learn more about Pave’s end-to-end compensation platform
