Slinging Crack Rock: Why Most Stock Options Suck…

Kris Dunn Compensation/Cash Money, HR (& Life!) Advice, Kris Dunn, Payroll, Policies

“Notorious B.I.G. said it best: ‘Either you’re slinging crack rock, or you got a wicked jump shot.’ Nobody wants to work for it anymore. There’s no honor in taking the after-school job at Mickey D’s. Honor’s in the dollar, kid. So I went the white boy way of slinging crack rock. I became a stock broker.”

Seth Davis in Boiler Room

In most ways, I’m a lot like any American. I’m for life, liberty and the pursuit of happiness.

Oh yeah—and I want to get rich off of stock options in any company I work for.  And that attitude makes me (and most of you) a complete fool.  A sucker, if you will.

I’m aware that Google has minted countless millionaires. I’m aware there are many stories of people who have become incredible wealthy off of the most primary LTI format out there—stock options.

But stock options are a lot like gamblers visiting Vegas. People who have had them pay off tell the story to everyone, but no one ever talks about shitty career choices made while they were chasing options that turned out to be complete and utter vapor.

Honor’s in the dollar kid. Vapor is the topic of your favorite Biz Markie song.

Let’s examine the Kris Dunn history with forms of equity:

1.  Young KD works for just formed Fortune 500 company and due to decent timing on when he joined, has stock options upon IPO and, at one time, can count a payoff near 7 digits.  Said company craters into bankruptcy, and young KD first connects the term options with the word “vapor.” Executive for company actually opens drawer and peaks in at a sheet to tell me the number of options I would receive upon joining in secretive fashion.  What could have possibly gone wrong with that type of LTI intro?

2.  Older KD works at another company past vesting point, and actually writes check to take options with him upon leaving said company.  Turnaround situation, so the strike price was dirt cheap. Company later sells and KD makes money.  Not “up yours” money, as evidenced by the authoring of this post and continued presence in working world.  Note skin in the game required to extend the option window past the point when he wanted to leave the company in question.

3.  Even older and jaded KD uses large portion of available assets to buy real minority ownership position in current company (Kinetix) and has uncomfortable feelings on a weekly basis knowing that the performance of that investment is largely up to him.

Which one is the best long-term incentive? It’s #3, the one where you bet your own money. This is probably a good illustration that the best LTI program mixes an investment by the employee in the company before any type of free equity is given.

And that type of equity would probably be of a higher grade than most.  Let’s face it, if you’re a normal employee, the average, pedestrian stock option system is rigged against you.

First, there’s the little matter of the type of stock options you have.  I won’t bore you with the details, but like Kool Mo Dee once said, there’s 50 ways to get ya.  If you’re an average individual contributor and you think you have the same types of options/stock program as your executive team, I’d encourage you to look again.

But wait!  Even if you have the same types of options as your executive team, there’s a new trend making your options worth even less than I’m suggesting.   The trend is called “liquidation preferences,” which means that when your company sells or liquidates, the owners of preferred stock get a guaranteed amount of money from the sale.   Here’s more on how it works from Business Insider:

“Often, the owner of preferred stock gets a guaranteed return of 1X their investment.

Imagine a VC that buys 50% of a company for $50 million, for a $100 million post-money valuation. If that company then sells for $75 million, the VC gets more than 50% of the $75 million. The VC gets his or her $50 million out first, and then half of the remaining $25 million ($12.5 million) for a total return of $62.5 million. The common stock holders split the remaining $12.5 million.

That’s a 1X liquidation preference. In recent years, it’s become the most common liquidation preference for VC firms investing in startups.”

It gets worse. VCs are looking more and more from a 2X liquidation preference, and they’re getting it.  Here’s how that one works:

“Imagine a VC that buys 50% of a company for $50 million, at the same $100 million post-money valuation. Imagine that VC has a 2X liquidation preference.

If that company then sells for $75 million, the VC gets more than 50% of the $75 million.

The VC gets the whole $75 million. Common stock holders get zilch.  In fact, common stock holders would get zero money unless the company sold for more than twice the amount the investors put in — in this case, $100 million.”

Two words—turd sandwich.

Don’t expect to get rich off stock options. That’s true now more than ever.

Honor’s in the dollar, kid.  The dollar in your hand.