Until it became common practice in the last decade to offer stock options to a relatively broad spectrum of employees, most people were content to receive stock options at all. Now, more savvy about compensation if bruised by the market downturn, employees more typically wonder whether the options they are offered are competitive with what they should expect from an employer in their industry, for an employee in their position. As more information has become available about the practices and functions of stock options, employees need solid data on stock options grant practices. Salary.com has researched the trends in high-tech companies during the dot-com boom.

In a startup, it’s not how many; it’s what percentage

Particularly in high-tech startup companies, it is more important to know what percentage of the company a stock option grant represents than it is to know how many shares you get. Don’t get caught up in the numbers, said Keith Fortier, a compensation consultant with Salary.com. In a startup, the meaning is in the percentages.

In a publicly traded company, you can multiply the number of options times the current stock price, then subtract out the number of shares times your purchase price, to get a quick sense of how much the options are worth.

In a younger company — where shares are less liquid — it is harder to calculate what your options are worth, although they are likely to be worth more if the company does well than the options you might get in a publicly traded company. If you calculate what percentage of the company you own, you can create scenarios for how much your shares could be worth as the company grows. That’s why the percentage is an important statistic.

To calculate what percentage of the company you are being offered, you need to know how many shares are outstanding. One Salary.com user was able to negotiate an extra week of vacation because he asked his prospective employer this question.

The value of a company — also known as its market capitalization, or market cap — is the number of shares outstanding times the price per share. A startup company might be valued at $2 million when an early employee joins the firm, but attain a value of $20 or even $200 million just a year or two later. Knowing that there are 20 million shares outstanding makes it possible for a prospective manufacturing engineer to gauge whether a hiring grant of 7,500 options is fair.

Some companies have relatively large numbers of shares outstanding so that they can give options grants that sound good in terms of whole numbers. But the savvy candidate should determine whether the grant is competitive in terms of the percentage of the company the shares represent. A grant of 75,000 shares in a company that has 200 million shares outstanding is equivalent to a grant of 7,500 shares in an otherwise identical company with 20 million shares outstanding.

In the example above, the manufacturing engineer’s grant represents 0.038 percent of the company. This percentage may look small, but it translates into a grant value of $750 for the stock if the company is worth $2 million; $7,500 if the company is worth $20 million; and $75,000 if the company is worth $200 million.

Annual grants versus hire grants in high-tech companies

Although stock options can be used as incentives, the most common types of options grants are annual grants and hire grants. An annual grant recurs each year until the plan changes, while a hire grant is a one-time grant. Some companies offer both hire grants and annual grants. These plans are usually subject to a vesting schedule, where an employee is granted shares but earns the right of ownership — i.e. the right to exercise them — over time.

Recurring annual grants are usually paid to more senior people, and are more common in established companies where the share price is more level.

In startups, the hire grant is considerably larger than any annual grant, and may be the only grant the company offers at first. When a company starts out, the risk is highest, and the share price is lowest, so the options grants are much higher. Over time, the risk decreases, the share price increases, and the number of shares issued to new hires is lower.

A good rule of thumb, according to Bill Coleman, vice president of compensation at Salary.com, is that each tier in the organization should get half of the options of the tier above it. For example, in a company where the CEO gets a hiring grant of 400,000 shares, the option grants might look like this.

Rule of thumb: each tier gets half the shares of the tier above it.