All stock options are not created equal

Feb. 1, 2001


Hundreds of stories about instant technology millionaires reinforce the possibility that you can "have it all"-engage in a challenging work environment, adjust your hours to meet personal commitments, and become rich through generous stock-option grants. For some, this reality seems especially fitting in the optical-networking space.

However, recent stories of disappointment and failure have emerged. Companies with promising and profitable futures report disappointing quarterly earnings, are unable to bring products to general availability, or have developed products for which customers are unwilling to pay. These companies experience a "hiccup" that is most visible in a declining stock price or a floundering pre-initial public offering (IPO) startup that never recovers. Unfortunately for the employees of these companies, the dream of wealth never materializes.

How can you be an intelligent consumer when evaluating a company that entices you by offering a large quantity of stock options? Consider two assumptions concerning stock-option grants as part of the compensation package:

Assumption #1:It's a better opportunity to "get in on the ground floor" and receive stock options in a pre-IPO company. The ability of a stock option to appreciate isn't necessarily a function of the grant price of your stock option. You might intuitively think that getting 5,000 options from Company A at $1 each is better than getting 5,000 options from Company B at $50 each. However, your appreciation would be the same if the $50 stock increased to $100 per share and the $1 stock increased to $50 per share. If you understand that either of these events can occur, then your decision-all other factors in the decision being equal-on whether to join Company A or Company B should not rest on the current market price of the stock option.

This is particularly relevant when you consider that your option grant usually vests over a four- or five-year period. Many option plans also include a "one-year cliff." In this case, you must wait 12 months for the first portion of your options to vest. If you have joined a pre-IPO company that is planning to go public soon, your appreciation calculation of your early options is not based on an early price "spike" following the IPO, but on successful consecutive quarterly results. It may take at least four to five years to know if your employment choice was a rewarding decision. Would you have been better to invest your four years in Company A or Company B?

As a young engineer searching for a promising future with a prosperous company, Keith Condict joined Ciena in November 1994 as one of the first 20 employees hired during its pre-IPO. Condict now affirms the importance of evaluating a company's future before accepting an offer.

"If a company offers a pre-IPO, it can be an attractive offer and enticement to join the company. But if the company never reaches the public offer, it doesn't benefit you," says Condict. "Obviously, the demand for bandwidth is explosive and it's necessary for everything in today's world-and bandwidth is nowhere near its potential growth. For that reason, among others, I knew that accepting a position with Ciena would provide me with a rewarding opportunity for future growth both personally and professionally."

Assumption #2:The stock price is in direct proportion to the strength of the company, its products, its sales, and its management team. A "good" company's stock price will rise and a "weak" company's stock price will fall. In the long term this statement is true. In the short term, imperfect information gathering, general market health, exaggerations by corporate marketing machines, and chat-line rumor mills can create enormous short-term volatility on a company's stock price. However, because you are required as a result of option vesting schedules to take a long-term view of your options' appreciation, you should concentrate on the long-term viability and strength of the companies under consideration. The following are some of the factors that will have a much greater impact on stock price than the initial grant price of your options:

  • Does the company have management that understands the customer's needs?
  • Is the company composed of research engineers and scientists who are trying to build a sexy product without regard to customer requirements such as product cost, product functions, and product availability?
  • Does the company understand the industry and have competitive knowledge of other market products?

"Before coming to Ciena, I spent significant time with the management team, grilling them with many questions," confirms Condict. "I learned from one of the founders that there was a very real market for the kind of products they wanted to build. And I was convinced from another manager that this production was realizable."

What is their time-to-market for this product and is it realistic? Only transforming technologies have the luxury of time. Often, competitive technologies are battling for customer mind-share, and the first to market achieves the footprint.

Can the company take the product beyond prototype to manufacturing general availability? Sometimes, a company can create a great prototype but doesn't have the skills to manage the iterative process for mass production.

How will competitors affect the company's ability to get product sold? Established competitors have techniques such as bundling and buying business that can kill even the best startup-and sometimes, just the sheer number of competitors in a given market can be a telling sign of things to come. For example, in the optical-networking metropolitan-network market, there are some 30 to 40 startups now vying for a piece of the pie.

"A solid management team will be in touch with these kinds of issues and will have a solid business plan to address them," says Condict.

Although stock options are an incentive to job seekers, they are also the most complex benefit to consider. For most, though, stock options are intended to motivate employees because they work more efficiently and more creatively to increase the company's value and, thereby, its stock price. To effectively evaluate a company's prospects, consider yourself the investor and evaluate the company as a potential long-term investment. Consider the strength of the management team, the viability of the marketing plan, the scalability of the business, and the company's competitive advantage.

To achieve both professional and personal goals, it is important for you to maximize the return on your investment. So be thorough about your re search and weigh your options carefully before making a costly decision.

Rebecca Seidman is senior vice president of human resources for Ciena Corp. (Linthicum, MD).

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