Options scheme in private company

aroominyork

My daughter has been offered a senior role in a private company. The package would allow her to participate in the company's options scheme with the stated intention of delivering a significant sum on exit. Can someone please explain how the price of options are calculated on entry and, perhaps more importantly, on exit in a private company where there are no market priced shares?

ChilliBob

Share options schemes can and often are complex, all are slightly different so I can only write from personal experience.

Options price will be the current year/periods price, usually you cannot *purchase* these options for a set period, perhaps three years.

Once you have purchased these options you will (if the company pay them) get dividends.

Also, hopefully, they will increase in value if the company does well and increases the value of the shares.

Regarding valuation, ultimately it can be whatever they want really since they are private. However, in practice they need soke methodology to get to it, but they're unlikely to divulge it! 

I think it's fairly common to undervalue the company, I can't quite remember why though.

As regards exit, typically that's if you leave the company (as a 'good leaver') or the company is purchsed etc.

It's worth knowing how it all works though as there are lots of different types of schemes, some more lucrative than others. It's good to be aware of the tax treatment of options when purchased, sold, dividends etc.

Bottom line if you believe the company to be going places and making a tonne more in a few years then yeah, thus could be really interesting. But, watch out for the details, there's lots of them! 

steampowered

aroominyork said:

Can someone please explain how the price of options are calculated on entry and, perhaps more importantly, on exit in a private company where there are no market priced shares?

There is a market price on exit!

It is just that it might not be a listed market practice. If the company gets bought by a private equity fund or by another company, there will be a value to that acquisition.

ChilliBob

Depends if you mean exit of the individual, or the company exit as as result of being sold!

aroominyork

Thanks Chilli for your first post, and you beat me to the 'exit' response. It's certainly more straightforward if the company is sold.

Would you recommend getting the terms in writing and showing them to an accountant? It's not just about evaluating the package but deciding whether to invest. 

Also, she negotiated base salary to reflect she will leave the senior civil service DB pension scheme. Is there a way to approximate present value (ie higher base salary) of that scheme?

MX5huggy

The value of the Civil Service pension?
Massive but start with the cost to the employer 27.9% or more if really senior https://www.civilservicepensionscheme.org.uk/your-pension/managing-your-pension/contribution-rates/

it’s not a relevant figure normally, but gives a guide to the magnitude of the value.

ChilliBob

aroominyork said:

Thanks Chilli for your first post, and you beat me to the 'exit' response. It's certainly more straightforward if the company is sold.

Would you recommend getting the terms in writing and showing them to an accountant? It's not just about evaluating the package but deciding whether to invest. 

Also, she negotiated base salary to reflect she will leave the senior civil service DB pension scheme. Is there a way to approximate present value (ie higher base salary) of that scheme?

I would recommend seeing the agreements yes. They may also mention other agreements, I believe mine was a shareholder agreement, separate documents for each type of share, and then the articles of association.

If this broadly makes sense then yeah, all good obviously if you want to be iron clad then having someone go over it like a lawyer is a good plan.

Truth be told I went straight into the role after uni and didn't think I'd be there long so I didn't bother! 16 years later I was made redundant with a bunch of shares from different schemes in different prices with all kinds of stuff to go through! Advice was helpful, and indeed mandatory then!

I'd say the key things to find out:
* When can you buy them, how much would they cost and what are the conditions - e.g. Time, performance/hitting targets etc
* How can you sell them, and is there a minimum holding period? - Will the directors/owners always buy them back
* What happens if you're fired?!
* if you cannot afford to buy the options when they come up, how long before they expire? - 7 years I think was mine, but it was three years since them being offered, so 10 in total, pretty generous!

Just some food for thought. It was complicated but worked out well for me for sure  

aroominyork

MX5huggy said:

The value of the Civil Service pension?
Massive but start with the cost to the employer 27.9% or more if really senior https://www.civilservicepensionscheme.org.uk/your-pension/managing-your-pension/contribution-rates/

it’s not a relevant figure normally, but gives a guide to the magnitude of the value.

Yes, 27.9% is the basis on which she negotiated losing the CS pension, but I do not understand how employer contributions are relevant to a DB pension. Surely contributions are only linked to benefits in a DC scheme?

Albermarle

aroominyork said:

MX5huggy said:

The value of the Civil Service pension?
Massive but start with the cost to the employer 27.9% or more if really senior https://www.civilservicepensionscheme.org.uk/your-pension/managing-your-pension/contribution-rates/

it’s not a relevant figure normally, but gives a guide to the magnitude of the value.

Yes, 27.9% is the basis on which she negotiated losing the CS pension, but I do not understand how employer contributions are relevant to a DB pension. Surely contributions are only linked to benefits in a DC scheme?

 

DB pension benefits are defined by the scheme rules. Typically involving a calculation based on years employed and salary. 
However the DB scheme needs to be funded, and normally most of the contribution comes from the employer, with a smaller amount from the employee. So this amount of funding gives an idea of the financial value of the scheme to the employee.
In a typical DC scheme, the contributions just go into a pot of money, with no specific benefits promised. When taking the pension, the pot of money is utilised to provide an income (in various ways).

aroominyork

Albermarle said:

aroominyork said:

MX5huggy said:

The value of the Civil Service pension?
Massive but start with the cost to the employer 27.9% or more if really senior https://www.civilservicepensionscheme.org.uk/your-pension/managing-your-pension/contribution-rates/

it’s not a relevant figure normally, but gives a guide to the magnitude of the value.

Yes, 27.9% is the basis on which she negotiated losing the CS pension, but I do not understand how employer contributions are relevant to a DB pension. Surely contributions are only linked to benefits in a DC scheme?

 

DB pension benefits are defined by the scheme rules. Typically involving a calculation based on years employed and salary. 
However the DB scheme needs to be funded, and normally most of the contribution comes from the employer, with a smaller amount from the employee. So this amount of funding gives an idea of the financial value of the scheme to the employee.
In a typical DC scheme, the contributions just go into a pot of money, with no specific benefits promised. When taking the pension, the pot of money is utilised to provide an income (in various ways).

OK, so it's just an indicative 27.9%. That's helpful to understand.