How Startup Options (and Ownership) Works

What it says, and how it holds up

Ten years on, Kupor's walk-through still answers the first questions an option holder is likely to have, though the US rules it cites are described as they stood in 2016 and may have changed. Written after a run of a16z posts on employee option plans, it follows a single made-up company, and Kupor, an investor, keeps an even tone about investor protections while saying plainly that a full ratchet truly dilutes employees. Ownership in a startup is a percentage at a moment in time, and a lot of what happens afterward can change it.

The walk-through is the value. An employee holding 1 percent of a 10,000-share company owns half that after a Series A doubles the share count, though each share is now priced at $1,000. A full ratchet, the harshest anti-dilution term, can hand earlier investors extra shares if a later round is priced lower, as happened to some Square investors at its IPO. Liquidation preferences decide who's paid first: sold for $100 million, his example leaves $50 million for common stockholders and option holders; sold for $15 million, it leaves $5 million, and with a 2x or participating preference they can get even less or nothing. He also explains why incentive stock options are taxed more kindly than non-qualified ones, how a late investor's veto over an IPO can become an economic lever, and the ways unvested options get handled in an acquisition, and near the end he argues that Rule 701, the SEC exemption companies use to issue employee options, should be updated so option holders get the information they need.