Before You Accept the Job, Understand the Basics of Stock Options and Long Term Incentives

There has never been a more exciting time to be in the biotech industry.  Scientific and technical advancements in the fields of gene and cell therapy that promise cures for HIV, cancer and rare diseases, in addition to record levels of investment have created a biotech jobs boom.  

With the abundance of job opportunities available, navigating the job market can surface many questions on which direction to take your career. Your job search may take you to an established commercial biopharma company that has already gone public and is a leader in their market, or you may want to join an early-stage biotech company that is backed by venture capital where you get to really roll up your sleeves and be part of building the business.

Both avenues have their distinct advantages for your career and can provide extremely rewarding experiences and growth opportunities.  Another distinction you will see between the two is in the offer package. Salaries, benefits, and stock options, also known as Long Term Incentives (LTIs), can be vastly different depending on the stage and size of the company you are joining.

Understanding the nuances and impacts of LTIs—from both a financial and professional perspective—can be challenging, so we’re going to explore some frequently asked questions about stock options and LTIs to give you the information you need to make the right decision for your next job.

This article will hopefully arm you with the basics, but it is not meant as financial advice. For that, please discuss LTIs with your financial advisor or a financial professional.

What you need to know about LTIs:

LTIs are part of most compensation packages at somewhat established life sciences companies. From startups who have raised a Series A round of funding to pre-IPO and later stage public organizations, LTIs are a very important tool to attract, hire, and retain the talent needed to achieve their goals.

LTIs are, in their simplest terms, the granting of equity or ownership in a company in the form of stock shares or stock options. LTIs are different from APIs, or Annual Performance Incentives, which include annual bonuses and other performance-based rewards. On a basic level, LTIs are a forward-looking incentive whereas APIs are awarded by looking at past performance.  

Generally speaking, at large publicly-traded life sciences companies, LTIs are part of the compensation package. However, in this case, LTIs are typically viewed as part of a bonus structure and usually have far less upside when compared to LTIs offered by a startup or pre-IPO organization. LTI rewards from larger, well-established publicly traded companies tend to be more predictable as their stock price tends to be less volatile. Thus, LTIs at larger companies tend to have less risk and not as high an upside yet are still a substantial way for you to grow your investment portfolio throughout your career. 

Startups and pre-IPO companies offer employees the potential upside of “getting in early”, so their LTIs represent much higher risk profiles but the potential for greater rewards. Employees who are part of early-stage companies can become millionaires through their LTIs if the company succeeds, especially in biotech. Silicon Valley is flush with millionaires who made their fortunes from LTIs.

“Stock options were part of what allowed me to retire at age 42 and then have some spare cash to come back out of retirement to start American Gene Technologies (AGT),” said Jeff Galvin, Founder and CEO of American Gene Technologies, in a statement for BioBuzz. “My first experience with stock options was at Apple Computer.  At Apple, there was a feeling of working for ourselves even in a 3000 person organization.  I loved the sense of being a ‘fellow owner’, and the relatively small initial stock option that I received as a manager in the international marketing department of the LISA Division allowed me to buy my first home in California.”

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Granting equity is important for these earlier stage companies because it creates an ownership mentality within the culture given that everyone is bearing risk and has “skin in the game.” Startups and emerging companies, for the most part, don’t want to hire someone that’s just there for a stable paycheck; they want someone that’s ‘all in’ and willing to take on a risk because they believe in the company’s science, technology, and mission.

Jeff Galvin added, “At AGT, every person and every function is critical.  We can only succeed together, so if we reach that success, we want to spread it around to everyone who helped.  Even entry-level stock options could make millionaires of young people that believe in our technology, vision, and mission.  It’s a natural filter for the team members.  If someone isn’t confident in the future, they won’t value the stock, and they won’t stay when offered a little more cash somewhere else.  Meanwhile, the dedicated employees who share a belief in our direction and goals will be ‘all in’ to make it happen.  That maximizes the chances of success and reward for everyone.”

Companies at these stages of development also tend to be more “cash poor” and are therefore more likely to offer a greater number of shares/options to an employee as a trade for a lower starting salary, for example. 

What is the Lifecycle of LTIs?

Again, all of this is a high-level overview of what can be a complex financial matter, but below is the typical lifecycle of shares/options that are part of an LTI package.

  • Grant. An employer grants shares and/or options at time of hire or as part of annual compensation review.
  • Vest. All LTIs will have a vesting period where an employee gains ownership of shares or options gradually over time. A standard vesting period is about four years (this can vary, of course). Below is an example of how a vesting period might operate:
    • Year one, 25% of shares or options become fully vested.
    • Years two through four, a percentage of shares or options vests each quarter.
    • If an employee leaves or is fired, they own only the shares that have vested.
    • After four years, that LTI tranche is able to be exercised by the employee.
  • Exercise. Once shares or options have vested, an employee can exercise shares/options by holding them or selling after the company has successfully completed an IPO. There are other exercise options as well, but these should be discussed with a financial advisor. 
  • Tax. There are tax implications to selling shares or options. The tax implications can be straightforward or highly complex. Securing the services of an accountant experienced with LTIs is a prudent move prior to exercising shares or options.
  • Track. The employer should provide a means for the employee to track LTIs via a digital platform. Employees should always have direct access to this information. 

What Is the Difference Between Shares, Options, and RSUs?

Broadly speaking, below is a breakdown of different types of LTIs offered by most startups and emerging, pre-IPO companies.

  • Shares. Shares are equity in a company that an employee does not have to purchase once vested. They are granted outright. Shares are more likely to be granted by early stage companies (startups, emerging, some pre-IPO) in larger volume as incentives for early hires. 
    • Shares are granted at a particular strike price determined by market research. So, for a startup, a strike price might be $3 per share. Once a company goes public, and the shares have vested, an employee can sell these shares outright without purchasing them.
    • The delta between the strike price ($3) and the stock price at the time of sale determines the payout.
  • Options. Options are also a form of equity. A stock option, essentially, provides an employee with the right to purchase company shares at the strike price established when the options were originally granted.
    • If an employee owns 1,000 vested options at a strike price of $10, that employee could purchase the shares for $10,000. They can either hold or sell. 
    • If an employee decides to sell the purchased shares, the delta between the $10 strike price per share and the current stock price at the time of sale determines the payout.
  • Restricted Share Units. Also known as RSUs, this form of equity is typically granted by more established companies with typically less volatility and risk profiles. Think big, well- established life sciences companies with strong pipelines or a commercialized product or two. RSUs generally have a more stable value but have far less upside than shares.

Questions you should ask your employer:

Now that you know the basics, here are some questions that you should ask your employer so that you can better evaluate your LTIs, know your options, and weigh them into your total offer package.

What is your share of the equity?

The amount of shares you may acquire if you exercise your stock options will be specified in your job offer. The number may appear to be extremely high, but it’s crucial to understand what your proportion of the stake is. You will want to ask your employer for the total number of outstanding shares in the company as a starting point, and what the governance is on increasing the number of shares in the future.  Once you know how many shares are outstanding, divide that number by the total number of shares to find out your stake at the company.

What is the Fair Market Value

The fair market value (FMV) is the worth of your company’s shares at a certain moment in time. At the time of stock option exercise, your employer should give you a reasonable market value for your shares. The FMV of a publicly-traded firm is simple to calculate. It’s usually the stock market closing price at the end of the day.

However, determining the FMV of a startup may be difficult because you won’t be able to obtain a price from the public market. As a result, startups will engage a third-party professional to estimate the FMV using recent rounds of funding, comparable company analysis, the size of the market, discounted cash flows, and anticipated revenue growth projections.

What happens if the company is acquired?

Before going public, many startups are acquired. You may want to know what will happen with your outstanding shares and stock options if your firm is purchased before your LTIs vest. In most cases, the acquiring firm will cash in your outstanding equity and option packages as a payout. However, it’s also possible that the acquiring company will trade employee shares and stock options for its own.  It’s good to seek clarity on this when possible. 

What happens if I leave the company?

You usually have 90 days from your termination from the company to exercise your vested stock options. It is up to you to exercise these options or not so don’t expect that the company will chase you down to sell your shares. Unfortunately, any non-vested stock options will be lost. 

The many facets of LTIs and their financial and professional implications can be intimidating. It’s very important for job candidates to understand that they can negotiate with employers for equity in a company. However, it is important to understand equity basics as well as perform research about a potential employer’s pipeline, lifecycle stage, technology, and leadership before finalizing any employment agreement.

Getting in at the ground stage at a life sciences company before they have a successful IPO can be a life-changing moment. 

Don’t leave that opportunity at the negotiating table.