Thinking About Thinking

What Option Grants Tell Us About The US Dollar

Posted in Economy, Venture Capital by larrycheng on November 3, 2009

Let’s start with the obvious.  When you receive an option grant in a private company, you are told a number of options.  The absolute number of options you receive is not as relevant as the percentage of the company it represents.  Your option grant is the numerator, but the denominator is key.  The denominator is the total number of shares outstanding in the company.  Obviously, if you are granted 10,000 options and there are 1,000,000 shares outstanding, you have been granted 1% of the company.  You are probably a direct report to the CEO.  If you are granted 10,000 options and there are 100,000,000 shares outstanding, you have been granted .01% of the company.  You are probably in an entry level role of some capacity.  It’s the percentage that counts. 

The more a company raises money by issuing more shares, the larger the denominator grows, and the lower your percentage gets presuming your option grant does not change.   It’s basic math: if the numerator stays constant, and the denominator keeps getting bigger, the resulting percentage keeps declining.  This effect is called dilution – which is never a positive word in our world.  No shareholder wants to be diluted.   For the readers of this blog, I suspect this principal is relatively obvious since many of you have worked within or around private companies.  OK, enough with the obvious. 

This very same principal applies to the value of currency which is why it surprises me when people are nervous, they decide to keep their money in cash (US Dollar).  In the world of currency, your numerator is the amount of US Dollars you have in the bank.  People feel safe because they have $x in the bank.  That’s the equivalent of people feeling properly compensated because they have 10,000 options.  It’s an incomplete equation.  You need to know the denominator.  In the case of the US Dollar, the denominator is the money supply.  The money supply is the “total amount of money available in an economy at a particular point in time.”  Just like in the option example, if you have a certain amount of cash in the bank, but the government keeps “printing money” to expand the money supply, your percentage of the money supply is declining.  It’s the currency form of dilution.  And here’s what’s happened to the US money supply:

money-supply

If I told you you could hold a fixed number of options in one of two companies: (A) a company that had to raise a ton more money and issue a ton more stock to do so, or (B) a company that is profitable and has to raise no more capital and therefore issue no more shares – all other things being equal, you’d take Option B every single time.  You’d take it because your ownership in the company would not be diluted.  But, why is the answer less obvious in currencies, when the principal is largely the same?  The US government is printing money and is the national equivalent of Option A.  It would seem more logical to look for the national equivalent of Option B and keep your money invested in that currency. 

Now there are lots of exogenous factors.  You can’t discount the fact that the US still has the strongest military on the planet.  And you certainly can’t discount enough the fact that I’m no economist and am probably missing many obvious points.  And, certainly, do not take this as investment advice.  This is just an exercise in thinking aloud which is what this blog is about.

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7 Responses

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  1. John Smith said, on November 3, 2009 at 2:08 pm

    you have it exactly correct. no obvious points missed. where did you get the data for your nice chart?
    John
    Geek Offices, Inman Square, Cambridge, MA
    coworking shared office space, all the office with none of the overhead

    • larrycheng said, on November 9, 2009 at 10:03 am

      If you just search for money supply chart on Google, there are many charts.

  2. slingster said, on November 3, 2009 at 10:38 pm

    An interesting dicotomy of behavior-currency inflation vs. stock dilution.

    Regarding stocks, its important to note that while the number of your stocks will undenieably dilute with the larger denominator, the total $$ value of those diluted socks might in fact not dilute, but be valued the same or greater than before the dilution. But of course, under certain circumstances the value can go down and then one is shit out of luck and pissed.

    Currency value is derived from a different metric. This is illusrtated by the fact that despite the dollar’s wild inflation, the dollar is still the prefered currency in most of the world’s black markets, markets where cash is king. This inflation resilience is ouf course due to the dollar no longer being backed by gold, but by faith in goverment.

    Why a black markerter in Thailand wants a dollar is because the dollar is put out by a country that spends more on their military in a year than the rest of the world combined; country that has built one of the best governmental systems in the world; has a phenomena legal system, etc etc-the intangables.

    • larrycheng said, on November 9, 2009 at 10:06 am

      Slingster – agreed. The US’s military might is basically an investment in economic stability and less on national security in my estimate. If there is a scenario where the world would migrate off the US Dollar as the reserve currency, I think we’re clearly testing that now. Major deficits, massive borrowing, and huge unfunded liabilities – and quantitative easing with super low interest rates? You can’t keep that up forever and maintain your reserve currency status. So, that intangible is being seriously tested right now witnessed by the dollars drop in relative value.

  3. Richard Shea said, on November 5, 2009 at 5:48 pm

    A big difference in the comparison is the fact that money is governed by fractional reserve and that money velocity factors in.

    Here’s an interesting chart comparing money velocity and money supply. It explains why the huge increase in money supply hasn’t resulted in rampant inflation.
    http://www.icmarc.org/xp/rc/marketview/chart/2009/20090529ChangesM1Supply.html

    The problem comes when velocity picks up, and whether the money supply can then be reined in. If not, we’re screwed like an option holder before a VC cramdown.

    • larrycheng said, on November 9, 2009 at 10:02 am

      Richard, thanks for the comment. I actually thought about showing the corresponding decline in money velocity. I guess the question is has the “dilution” already happened purely by the increase in money supply? Or does the dilution happen when the money velocity returns to normal with an increased money supply?

      I’m inclined to think that the dilution has already happened, purely based on money supply increase. But, it won’t be “realized” until some normalcy in velocity. To use the VC analogy – you get diluted when new money comes in, but you don’t “realize” it until the exit happens.

  4. grants360 said, on February 2, 2010 at 2:36 am

    Been searching for information just like this thanks for getting it out there.


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