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| 0 8640 You should do these calculations in your journal yourself as we discuss them. | |
| 8640 14600 Morgan and Catherine decide that the right sales head needs to be in their 40s and would | |
| 14600 21600 probably be drawing around $200,000 per annum currently, but they can only afford to pay | |
| 21600 24080 $75,000 per annum. | |
| 24080 29240 So they need someone who resonates strongly enough with their non-financial vision to | |
| 29240 36000 consider that salary and top that up with an attractive stock option strategy. | |
| 36000 41920 They consider this role to be of the highest criticality rating, that is A, and agree | |
| 41920 47000 that an attractive intended benefit for such a person should be at least eight times their | |
| 47000 49400 current annual worth. | |
| 49400 55440 They realize that this amount is not a guarantee from their side, but will be realized only | |
| 55440 58920 if their business grows to a certain value. | |
| 58920 63360 Seeing the right person who resonates with their values and vision is key to achieving | |
| 63360 70360 that growth, and if they can find one, the financial benefit must also be attractive. | |
| 70360 75600 A benefit of eight times in four years means that the sales head should be able to make | |
| 75600 81320 $1.6 million after four years if things go as planned. | |
| 81320 83360 But what is that plan? | |
| 83360 87040 They need to drop their financial projections next. | |
| 87040 92040 They have only started up a few months ago and have a half-finished product with them. | |
| 92040 96360 They estimate their growth over four years and believe they would raise venture capital | |
| 96360 98480 during this period. | |
| 98480 103440 This would increase their number of shares, so they estimate the share capital to increase | |
| 103440 109360 to 40,000 shares, from the current 10,000 shares in four years. | |
| 109360 114760 They estimate that given the current market saturation in the education sector, it might | |
| 114760 118760 take them some time to make a dent with their uniqueness. | |
| 118760 123880 They estimate their company valuation at $40 million after four years. | |
| 123880 131880 $40 million divided by 40,000 shares leads to a share price of $1,000 per share after | |
| 131880 134160 four years. | |
| 134160 140440 Since the intended benefit to the sales head is $1.6 million, they would need to grant | |
| 140440 147400 1,600 options, assuming the options are granted at, say, 1 cent or almost zero exercise | |
| 147400 149640 price today. | |
| 149640 155320 So the arithmetic is done and now they have a number, 1,600 options. | |
| 155320 162640 But then they look carefully and realize that 1,600 options amount to 16% of their current | |
| 162640 165400 capital of 10,000 shares. | |
| 165400 168560 And this is just the sales head we are talking about. | |
| 168560 172920 They also need to grant stock options to a few other team members. | |
| 172920 175080 Something is not right. | |
| 175080 179280 So they start looking at each number more carefully this time. | |
| 179280 182120 First, the intended benefit. | |
| 182120 187480 They have considered it at eight times the current market worth of $200,000, which comes | |
| 187480 189840 to 1.6 million. | |
| 189840 195440 They could reduce that, but they realize that the intended benefit must be really attractive, | |
| 195440 202080 so for now they decide to keep it at 1.6 million and consider the other figures first. | |
| 202080 208040 Next, they notice they have considered the total number of shares in the fourth year at | |
| 208040 210400 40,000 shares. | |
| 210400 215560 They start analyzing that number and conclude they should be judicious by raising capital | |
| 215560 222040 from the investors and also raise it at a good valuation so they don't dilute much. | |
| 222040 227520 But that would mean delivering a really strong product with a healthy revenue. | |
| 227520 232360 That would come not just from adding more people to the team, but by strengthening the | |
| 232360 234520 core of the product. | |
| 234520 239680 So they make a mental note that if they wish to reduce their equity dilution but still | |
| 239680 246360 make the company valuable, they need to solidify the vision to attract the right people and | |
| 246360 250440 think deeply about the value proposition of the product. | |
| 250440 256200 They revise the total number of shares in the fourth year to 20,000 shares, from 40,000 | |
| 256200 258080 shares. | |
| 258080 262000 Then they consider the valuation of 40 million dollars in the fourth year. | |
| 262000 268000 Now, this is not just about changing 40 million to something else so that the numbers fit | |
| 268000 269500 well. | |
| 269500 274840 It tells them something very important about their stock options strategy. | |
| 274840 282520 If they wish to give out 1.6 million as intended benefit, they have to get to a much higher | |
| 282520 283920 valuation. | |
| 283920 288920 The valuation of 40 million is certainly a good number, but at that valuation they may | |
| 288920 295440 not be able to justify an intended benefit of 1.6 million dollars. | |
| 295440 302960 So either the intended benefit needs to reduce or the value per share needs to go up. | |
| 302960 308280 As they still wish to preserve the intended benefit, they revise the fourth year valuation | |
| 308280 310800 to 1.60 million dollars. | |
| 310800 315080 But they now make a mental note that this would mean a certain amount of revenue to be brought | |
| 315080 316240 in. | |
| 316240 321400 And they need to ensure even more that their product is far better than what others have | |
| 321400 323040 an offer. | |
| 323040 327160 This does not mean more advertisements and more customer phone calls. | |
| 327160 332920 It means more contemplation on how that product could become valuable. | |
| 332920 339240 More physical labor, more resources without any additional intellectual labor may not | |
| 339240 341000 help much. | |
| 341000 346080 By contemplating deeply about their product, they can significantly increase its value | |
| 346080 352800 proposition, enhance valuation without spending a single extra dollar. | |
| 352800 357760 Reducing the fourth year shares to 20,000 and increasing the fourth year's valuation | |
| 357760 365560 to 160 million dollars brings down the number of options to be granted from 1600 to 200 | |
| 365560 372680 options, which is 2% of their current capital and 1% of the capital in the fourth year. | |
| 372680 377560 Now if the eventual valuation were to get to a billion dollars, then the employee ends | |
| 377560 380360 up making much much more. | |
| 380360 385720 Similarly, if they were to reach only 40 million in valuation, those 200 options would | |
| 385720 388120 fetch much lesser. | |
| 388120 394720 So their strategy rewards the employee reasonably in case of a certain growth trajectory and | |
| 394720 400160 rewards them exponentially in case of an exponential growth. | |
| 400160 405280 Next they take up the other potential team members and rate them A, B or C depending upon | |
| 405280 410480 the criticality of their role and apply a descending multiple to compute their intended | |
| 410480 411580 benefit. | |
| 411580 414560 The process is the same. | |
| 414560 419800 Now they could further reduce the number of options by reducing the multiple or increasing | |
| 419800 425080 the valuation in the fourth year or decreasing the number of shares in the fourth year even | |
| 425080 426440 further. | |
| 426440 431420 But what you need to focus on here is the process. | |
| 431420 437640 Look at how the intended benefit can sometimes guide you to take decisions about your business. | |
| 437640 443680 As far as possible, try not reducing the intended benefit. | |
| 443680 449420 The key takeaway is let your vision and intellectual capital drive your stock option | |
| 449420 451400 strategy. | |
| 451400 455520 Use your non-financial vision to attract the right people. | |
| 455520 459940 Use deep thinking to infuse value into your product. | |
| 459940 465680 Valuation will take care of itself and your journey will be much more meaningful and enjoyable. | |