Certified financial planner Jeff Rose answers: Part of the compensation package will include equity, or stock options. My question is, how do I negotiate a 'number' of these options to compensate for a lower salary over the next couple of years? Is there a formula for that? Also, from the company's point of view, would the value of equity offered be tied directly to the perceived difference between the salary offered and the prevailing market rate?

In recent decades, and particularly in the IT field, stock options have become increasingly popular as a method of compensation.

But should you accept stock options in lieu of salary? Let's start by saying that there is no mathematical equation to help in determining the balance between salary and stock options. Sometimes referred to as employee stock options, or simply ESO's, they are granted by an employer, enabling the employee the right but not the obligation to purchase a certain number of shares at a specific price and at a specific point in time in the future.

They're most commonly offered to managers and officer-level positions. Options usually have expiration dates. If the options are not exercised by those dates, the options will expire and become worthless.

There is also a vesting period, after which the employee will have full ownership over the options. Vesting might occur over, say, five years. Vesting is a strategy that employers use to keep employees with the company for longer periods of time. The market value of the stock at the time the options become vested determine the value of the options.

And naturally that can never be known at the time the options are granted. After two years with the company, the employee is vested in another shares. If the options expire before that price is reached, they will become worthless. What makes those two words so dangerous?

And "rumored" means that whether or not the company will actually go public is still subject to some speculation. Meanwhile, the fact that the event is not expected to take place for at least another year means that the stock doesn't even exist right now. The options therefore represent a complete unknown. Due stock options startup employees market factors alone, there is always the risk of options becoming worthless, even with a well-established blue-chip company.

All that needs to happen is for the market price of the stock to fall below the exercise price of the stock options startup employees. The situation is of course much more problematic with a startup company. There's no way to know what the market reaction will be to the stock once it goes public.

Though we hear of initial public offerings rocketing out of the starting gate and making the holders rich, stock prices fall at least as frequently. That means that it's entirely possible that the salary the employee will give up in favor of stock options will never materialize.

How to assign stock options in early-stage startups

The employee will be betting that the future of this upstart will be very positive and the company's stock will be well received by the market. But if circumstances don't break in that direction, he could not only be at risk on his job but how does the mafia make money from gambling on his projected investment in the company's stock.

Adds Russ Thornton, certified financial planner and founder of Wealth Care for Women:. If this person is going to receive a paycheck from this company, his income is already going to be largely dependent on the fortunes of the company. In that situation, the employee will win if the stock price rises above the exercise price once the options are vested.

Shares vs Stock Options | Mike Volker – Vancouver's Green Angel and Tech Innovator

And if the value of the stock never reaches the exercise price, the employee loses nothing. But that's not the situation with this startup employer. The best strategy for this employee is to negotiate a market-level salary. That will eliminate the risk of the many variables connected with the options, such as if the company will actually go public, how well-received the stock will be when it does, the exercise price level of the options, and what the vesting schedule might be.

These are all variables that cannot be adequately factored into the decision at this point.

Go with the market-level salary, and negotiate for the stock options as a secondary consideration. This post is part of a continuing series that answers all of your questions related to personal finance. Have your own question? Jeff Rose is a certified financial planner professional, and CEO and founder of Alliance Wealth Management LLC, an investment advisory firm.

Jeff is an Iraqi combat veteran having served in the Army National Guard for nine years, including a 17 month deployment to Iraq in Why big data can make HR more important. You are using an outdated version of Internet Explorer. For security reasons you should upgrade your browser.

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ASK A FINANCIAL PLANNER: Is it worth taking a salary cut to get stock options at a hot startup? Jeff RoseContributor.

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