An option grant letter should show the preference stack

I think the standard grant letter of a venture-backed software company misleads the people who sign it, and that the fix is simple enough to be required by any board that takes its employees seriously. My position is that every option grant, and every annual equity statement after it, should show the employee what their holding would be worth after liquidation preferences at several exit values, including at least one at which it is worth nothing. A valuation headline without the preference stack is not information an employee can use. It is a number they will multiply by the wrong thing.

I came to this view late, and from a position of some responsibility for the problem. Between 2021 and 2023, Kestrelford granted options to several hundred people, including many I had hired personally. The grant letters stated the number of options, the exercise price, the vesting schedule and, in the covering email, the valuation of our most recent financing. They did not say that our investors held preferred shares carrying a right to be repaid before common shareholders received anything. Many colleagues did what anyone would do. They divided the headline valuation by the number of shares, subtracted their exercise price and arrived at a figure they began to think of as theirs.

What the grant letter left out

In April 2024 we raised C$150 million at a post-money valuation of C$1.9 billion, against C$3.1 billion in 2021. The third-party valuation of our common shares fell from C$13.40 to C$5.90, and 612 colleagues held options priced above it. I spent much of that spring in rooms in Waterloo, Toronto and Montréal, and in video calls with remote colleagues in the United States and the United Kingdom, explaining what had happened. The question I heard most often was not about the new price. It was some version of this: why had nobody told us that C$720 million would be paid to investors before we saw anything?

Nobody had hidden it. The preferences were in our articles and shareholder agreements, and any employee with the patience and the right documents could have worked them out. But we had not put them in front of anyone. We had communicated equity in the language of the financing announcement, which is written for investors and the press, and assumed that employees would translate it. Most did not, because nobody translates a document they believe is good news.

The cost of that silence became visible all at once. People who had made decisions on the basis of their imagined holding, such as turning down a better-paid offer elsewhere or delaying a house purchase, felt that the company had let them believe something convenient. Some were right. I would rather they had been angry with me in 2021, about a smaller number, than in 2024 about a larger one.

Four exit values, one of them painful

Since 2025 every Kestrelford option holder receives an annual statement, in English and French, with a table showing the value of their vested and unvested options at four exit values for the whole company. One is below the total of the preferences, and at that value their options are worth nothing. One is close to our latest financing. Two are higher. Each value is calculated through the actual waterfall: preferences first, then common shares, with the option holder's exercise price deducted. The statement also explains in a paragraph what a liquidation preference is and why investors ask for one, without suggesting that they are wrong to.

The statement does not predict an outcome. It shows a range, and its purpose is to make the employee's arithmetic as good as the board's. We chose four values because two invited people to treat the higher one as a forecast and six made the table hard to read. Our finance team prepares the figures from the same model our board uses, and our outside counsel reviewed the wording.

The response surprised me. I had expected the zero line to frighten people. It mostly reassured them, because it showed that the company was willing to say the uncomfortable thing first. In our survey the following autumn, agreement with the statement that people understood the value of their equity rose from 29% to 74%. Requests to HR about equity fell by roughly two-thirds. A small number of people told us the statement had changed their decision about whether to stay, and in both directions. I count that as success. An employee who leaves because they understand their equity correctly has made a better decision than one who stays because they did not.

The objections I heard in the committee

The first objection was that a table of exit values amounts to forward-looking disclosure that could create liability. Our counsel's view was that a clearly labelled illustration of a mechanism, built on stated assumptions and making no forecast, carries less risk than allowing employees to rely on a headline valuation they have misunderstood. I am not a lawyer, and another company should take its own advice. But the risk of saying nothing is not zero either.

The second objection was that the statement would make recruiting harder. A candidate comparing our offer with one from a company that shows only a headline valuation might choose the other. That has happened a few times. It has also happened that experienced candidates, especially engineers who have been through a down round elsewhere, chose us partly because we showed them the table. A recruiting advantage built on an employee's misunderstanding is not one I want to defend later.

The third objection was the most serious. One director said that employees, unlike investors, cannot negotiate their preferences, so showing them the stack invites resentment without offering any remedy. I think that confuses two questions. Employees cannot change the preference stack, but they can decide how much of their pay to take in equity, whether to exercise vested options and whether to stay. Those are real decisions, and they deserve real numbers.

The practice I would ask other boards to adopt is narrow. Do not stop granting options and do not stop announcing financings. Add one page to every grant letter and every annual statement, showing the value after preferences at several exit values, one of which is painful. Prepare it from the board's own model. Then ask your people and compensation committee to read it as an employee would. If the committee would rather the page were not sent, it has learnt something about what its employees currently believe.