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:
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.