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Stock option confusion: Pre-IPO vs IPO Price

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Stock option confusion: Pre-IPO vs IPO Price

Old 12-12-2011, 03:58 PM
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Default Stock option confusion: Pre-IPO vs IPO Price

A buddy of mine was granted "Pre-IPO" stock options in the tech company he works for not too long ago. For the sake of argument, let's say he got 1000 options at a "share price" of $20.

Fast forward a few months and the company has declared they are, in fact, going public. However, their IPO is expected to open at ** $8 ** a share which everyone believes to be fair market value. In other words, the stock is expected to open 60% lower than his pre-IPO options were priced at just a few months prior.

What am I missing here? What incentive did the company have to give him pre-IPO options that are valued CONSIDERABLY higher than the actual valuation of the company? Is this some sort of sneaky retainment tactic or am I misunderstanding something? From the paperwork, it looks like no share dilution/creation is taking place during the IPO.

I can't imagine the company "accidentally" got their own value wrong by more than 100% per share?
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Old 12-12-2011, 04:08 PM
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Maybe his option is for preferred shares?
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Old 12-12-2011, 04:08 PM
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Made him feel good for a while, didn't it?
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Old 12-12-2011, 04:25 PM
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You can value private company shares at whatever you want. "You" being the majority shareholder and/or Board of Directors.

There are different methods for valuing a private company, but at the end of the day (hey, will I get kicked in the nads for using that term?), if you price shares and someone buys them, that's a transaction. Banks and VC firms won't accept some arbitrary or Chinese math valuation, they will do their own.

I would say that your buddy didn't really know much about how companies get valued in the public market, and apparently $20 bucks a share was far too high.


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Old 12-12-2011, 06:33 PM
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He got the option to by at a price. If the stock goes higher than that, he can exercise the options and make money. If it never gets there (while the options are still valid), he can't make any money, nor loses any...
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Old 12-12-2011, 06:37 PM
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Originally Posted by ericinmich View Post
He got the option to by at a price. If the stock goes higher than that, he can exercise the options and make money. If it never gets there (while the options are still valid), he can't make any money, nor loses any...
I understand - what was confusing to me is I had never heard of options getting a base price outside of fair market value. (unless they were to insiders and priced at pennies on the dollar) Obviously FMV is pretty clear when the stock is being traded publically, in this case though his options were "pre-IPO" and I am confused as to why the company would value themselves at 2.4x the IPO price, and then distribute stock options as such to employees.
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Old 12-12-2011, 07:15 PM
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Maybe his shares got diluted because of new preferred stock being offered?
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Old 12-12-2011, 07:48 PM
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Originally Posted by Flot View Post
I understand - what was confusing to me is I had never heard of options getting a base price outside of fair market value. (unless they were to insiders and priced at pennies on the dollar) Obviously FMV is pretty clear when the stock is being traded publically, in this case though his options were "pre-IPO" and I am confused as to why the company would value themselves at 2.4x the IPO price, and then distribute stock options as such to employees.
The stock options I have received in the past were always 10% lower than the lowest trading price for the most recent 6 month period. This makes sure the option is actually worth something if you decide to 'sell to cover'.

Ask your buddy what the current share price is? The next thing is how it's been fluctuating recently. Most stocks have been up and down quite a bit.

If the price has been between 15 and 25, the options could be of value as long as he knows when the price peaks. If the price is lower than 20 and hasn't been above 20 for a long time, he might have been given worthless options.

The IPO price is one price. The general public does not get this price. The guys who put up the capital for the expansion or whatever is driving the IPO want to make a profit. They make that profit when the shares are traded to the public.

There is a chance the IPO shares and all shares will go up after the IPO is completed. The key is, what is driving the IPO? Companies issue new stock to raise capital for a new product line, expansion and other reasons. These new business opportunities can result in a run up of the stock price.

I hope this helps.
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Old 12-13-2011, 04:05 AM
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Was there or will there be a stock split pre-IPO? Let's say there is a 4 for 1 split just prior to the IPO. His price would adjust to $5.
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Old 12-13-2011, 06:01 AM
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Another defination goes something like pre-IPO means betting with the 'house' (underwritter) that the price will go up. Essentually a free loan for the house. You get to find a good accountant who will use the lower tax rate for you compared to regular income.

Feelin lucky.......
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Old 12-13-2011, 08:31 AM
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There is also a possible §1202 and §1244 advantage to this stock offering. There are numerous exclusions and requirements that go along with this but the general idea is:

Qualified Small business stock has very tax preferential treatment when it becomes either worthless or sold at a gain. One of the requirements is purchase at initial offering. By offering Pre-IPO options, they are allowing for this potential treatment for the employees of the company.

THERE ARE TONS OF RESTRICTIONS THAT WILL VOID THIS TREATMENT. I AM MERELY SPECULATING AND NOT OFFERING ANY ADVICE.

Tell your friend to talk to a CPA about this. There are numerous restrictions that have to be met to get this treatment. Options are considered original issue even if you exercise them later but there is an asset test that can void this. Like I said, this is one consideration and one I'd look into.

I've seen clients try to claim it. More often than not, something was done wrong that makes §1244 and §1202 invalid. Tread carefully.
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Old 12-20-2011, 04:01 AM
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PreIPO valuations are usually determined as a a tradinging indicator for that sector. IE Multiplier effect of earnings. Did revenues shrink, or the balance sheet fall since he was issued the pre-ipo shares?

Technology stocks are really tricky as some of them have no revenues and the value is all in the idea.. IE groupon. Well that is dependant on what groupon accounting standards you choose
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Old 12-21-2011, 08:08 PM
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When you say, "Fast forward a few months..........", that covers a lot of ground, and anything can happen, especially in tech, including cancellation or postponement of the IPO. Look at what happened at Zynga(ZNGA) in the run up to their IPO last Friday, and you could be talking about your buddy's situation in a nutshell.
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Old 12-22-2011, 03:11 PM
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Could be the offer of $20 was when the company was looking at 1-million shares, total, then when they got around to an actual public offering they decided to dilute to 2.5-million shares. Without knowing the total number of shares then, and now, there is no way to say if the $20 was pulled out of someone's ass or if it was a genuine offer of goodness.
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