Session 15: Organization Development III: Compensation

Tuesday, February 25, 2020
Summary: Barbara Arneson must decide which job offer to take. With all other factors being equal, she is now down to a decision based on the value of the equity compensation offered by each company (i.e., the stock options). One company is a public company with easily gathered data on its financial status. The other company is a start-up which has only financial projections. This session is a great chance to learn about the four essentials of stock options: the length of the vesting period, the strike or exercise price, estimating the market price at some future point, and the number of shares currently outstanding at the enterprise.

Quote of the Day: “Fortune favors the prepared mind.” Pasteur

Study Questions (Policy on Study Questions.)
  1. Review these basic formulas and information regarding venture finance:
      • Earnings per Share (EPS) = Earnings / Number of Shares Outstanding
      • Share Price = Earnings per Share * PE Ratio
      • Market Capitalization = Share price * Number of Shares Outstanding
      • Note: "Earnings" is often called Net Income or After-Tax Profit
  2. The current number of shares outstanding for BioGene is 23 million and its current PE ratio is 49. Assuming a yearly growth in earnings of 50 percent for the next four years and a decline in PE ratio to 25, this implies a valuation of $962 million in 2022. Assume InterWeb's earnings (after-tax profits) in 2022 are $6.3 million as stated in their business plan. Assigning a PE ratio of 50 of InterWeb in 2022, what will their valuation be?
  3. What is Barbara’s percentage ownership in each firm assuming nothing else changes in shares outstanding for either of them in the next four years when the options vest? Recall from the case that BioGene has 23 million outstanding shares, and InterWeb has 23.7 million outstanding shares.
  4. Using the valuation estimates in Question 1 for 2022, compare the offers in four years when the stock options will be fully vested. Assuming Barbara remains employed until that time and can sell her options in a cashless transaction on the same day, which stock option offer yields a larger gain? Make sure to include the cost of the stock options and state all critical assumptions.
  5. In addition to compensation matters, what other factors would you suggest Barbara consider in making her decision?
Required Readings (Policy on Required Readings.)
  • Case: Barbara's Options ... see Files section of Canvas for a copy (also available in the Appendix of the Technology Ventures textbook, pages 538-541). Also available below in the Handouts section of this page.
  • Review the E145 slides regarding venture finance from earlier Sessions 9 and 10.
  • How Stock Options Work from Inc. Magazine
  • Price-Earnings Ratio (P/E) Definition
Recommended Readings
  • Read from the middle of page 9 to middle of page 10 "Introduction to Stock and Options" by David Weekly; skim all the rest.
  • Read Section 12.5 of Technology Ventures textbook.
Online Assignment (Policy on Case Analyses.) All students submit.

All other factors being equal, and based on the stock option packages only, I would accept the (BioGene/InterWeb -- choose only one) offer because ...

Note: Please submit a numerical analysis along with your assignment. This is an individual assignment. You are encouraged to discuss the case with your teams, but each student must submit his/her own write up reflecting his/her personal decision.