I ran the numbers for this guy, but I'll make some up here to show the process I went through. It went like this:
Here is an offer $100K/yr 100K shares vesting over 4.
Counter $150K/yr, 100K shares.
My counter $150K/yr, no equity.
This is this math, I've got a fixed amount of money in the bank, its going toward zero. I can sell your 100,000 shares to one of our investors for $2/share, giving the company $200,000 which I will then pay out to you $50K per year on top of your $100,000 a year salary. You get $150K per year, the investor gets the 100,000 shares. Or I can give the 100,000 shares to you with a strike price of $0.25/share, vesting over 4 years. So at the end of the four years you will have one of three outcomes.
1) $130,000 in the bank (that is $50 - 35% marginal tax rate) * four years.
2) A right to buy $xxxK of stock for $25,000.
3) A different job.
So realistically the stock needs to be worth $300K and saleable for you to make money. ($300K - $25K exercise - approx $137.50K in taxes) So $3/share. If I have investors willing to pay $2/share for common stock today, you (the engineer) need to believe that in four years the common stock will become 50% more valuable. You've got to ask yourself one question, "Do I feel lucky?"
For lots of people though its also more 'fun' to work in a startup in terms of engaging problems to solve and level of impact on the company is involved.
If you have recently sold stock at a $2 valuation, you should be very wary about issuing options at $0.25. This will put you across the ISO/NSO line and has tax implications for the employee.
If you haven't actually sold stock recently, you are probably better off using ptacek's formula and computing future value rather than present value, and avoiding pricing your stock at all.
The numbers were fictitious in order to work the example. Our CFO in conjunction with our general counsel determines the effective valuation which is ratified at the appropriate board meeting and becomes the official strike price until the next valuation 'event'.
There are two numbers in play, one is the value of common stock and one is the value of preferred stock. Preferred stock is used in conjunction with raising capital and often has terms and covenants attached to it which make it significantly more valuable than common stock early in the company's life cycle where they effectively converge on the same value at the IPO (or 'liquidity event')
That said, the example is illustrative but not strictly accurate (accurate in principle but not in execution). What really happens is that you run out of money faster with a higher salary load, and that means you may need to raise additional funds sooner. That fund raising round would proceed like any other round, caveat your 'target' now includes an additional $200K to cover the salary you're paying out. Worse that stock you sell will be preferred and not common stock, and as such might have preferences like 2x return which would further reduce the benefit to common stock holders in the event of a sale or merger.
Its truly a good prisoner's dilemma game setup. If all of the employees take large common stock grants and low salaries they all benefit more on a non-IPO type event, if a few take big salaries they can make the threshold for everyone else benefiting higher, thus by not co-operating get a better salary and reduce total compensation of their peers.
I ran the numbers for this guy, but I'll make some up here to show the process I went through. It went like this:
Here is an offer $100K/yr 100K shares vesting over 4. Counter $150K/yr, 100K shares. My counter $150K/yr, no equity.
This is this math, I've got a fixed amount of money in the bank, its going toward zero. I can sell your 100,000 shares to one of our investors for $2/share, giving the company $200,000 which I will then pay out to you $50K per year on top of your $100,000 a year salary. You get $150K per year, the investor gets the 100,000 shares. Or I can give the 100,000 shares to you with a strike price of $0.25/share, vesting over 4 years. So at the end of the four years you will have one of three outcomes.
1) $130,000 in the bank (that is $50 - 35% marginal tax rate) * four years.
2) A right to buy $xxxK of stock for $25,000.
3) A different job.
So realistically the stock needs to be worth $300K and saleable for you to make money. ($300K - $25K exercise - approx $137.50K in taxes) So $3/share. If I have investors willing to pay $2/share for common stock today, you (the engineer) need to believe that in four years the common stock will become 50% more valuable. You've got to ask yourself one question, "Do I feel lucky?"
For lots of people though its also more 'fun' to work in a startup in terms of engaging problems to solve and level of impact on the company is involved.