Tuesday, June 28, 2011

tax-back flipping options - Providing communal share liquidity

Communal Equity Options (deposit options) are a useful tool for attracting partners to a commune since they allow option recipients to participate in the future growth of the commune with minimal financial risk.  This article is most useful if you have read deposit options and communal equity descriptions.

Another option variation that is generally useful can be called a tax back flip option.  Either the option buyer or the seller(s) can have the right to flip the shares immediately at a fixed taxed percentage between 10% and 50% of the profit from the option trade.  For general speculative stock options,  the net result is that the option seller keeps his stock (for cheaper than it would cost to buy it in market), and pays cash to the option buyer in order to settle the trade.  The advantage to a buyer that intends to flip the underlying stock, if exercised, is that he doesn't need to have the cash to buy the stock, and is saved the price risk of trying to resell it right away.  If the option seller is the one with the flipping rights, then the cost of the option will necessarily be lower than a regular option without tax back flipping rights.  For general stock options, a tax-back flipping right is only moderately useful, because almost the same results from the sellers perspective can be achieved by selling only half the options if the tax-back right is 50%.

In the context of communal equity principles, a tax back flip option is much more useful.  First, there are restrictions on preventing any entity from owning more than 1 share so this allows existing owners or option holders to acquire other options, and second it solves the issue of employees not having the capital to exercise their option without a secondary trading market to flip it themselves.

Recall that whenever a new partner joins the commune new cash is available from the buyer for the partners.  Under communal equity principles, a tax back flip option is a right of the option holder to intercept part of those funds as his option exercise.  For example, if a new 20th partner is about to join the commune at a communal equity value of 10M, and someone else has a communal equity deposit option with 3M strike price and  20% tax-back flipping rights,  then if the option holder exercises his flipping rights, the new partner pays 500k (1/20th of 20M); the communal partners receive (1/20th of (3M + 20% of 7M)) 220k, and the option holder receives 280k (80% of 7M).  From the communal partners perspective, the commune is less diluted than it would be if the option holder also joined, and they receive additional cash inflows.  So the most important benefit of all for tax-back flip options/rights is providing liquidity in communal shares that is regularly lacking in partnerships.

Because the tax-back flipping right is held by the option buyer, it doesn't lower the premium he is willing to pay for the option because it is an additional right.  As a generic rule, communal partners should be willing to immediately repurchase a share for 80% of what they just sold it for, because if they are not willing to do so,  the implication is that they are selling it for too much.  A 20% tax-back rate is also a sufficient general incentive for owners to seek maximizing the communal equity price sought from new partners.   Because the option buyer's right to flip back has no tangible inconvenience to the partners that issue the option, there is no reason to want higher option premiums from the buyer.  Its almost like a retailer offering to buy a brand new still-in-package item for 80% whenever it sells such an item.

Since the tax-back flipping right can be offered to an option buyer without affecting the value desired or payable of the option, at a 20% tax-back rate, the right can simply be offered to all option holders as well as communal partners.  Whenever a new partner buys into the partnership, the commune can simply set a 20% tax-back rate as a minimum, and hold an auction for all option holders and partners to bid up the transaction's tax-back rate.  Option holders are advantaged in this auction because the tax-back rate applies only to the difference between their option strike price and the new partner purchase amount, while the tax-back rate would apply to the entire transaction amount for existing partners.  Technically, the commune could also find the opportunity to re-auction the proceeds from the first auction at a 10% minimum tax back rate in case there is substantial pent up demand to liquidate communal partnership positions.  

For instance, in the first example on this page, a 10M communal equity transaction and 3M strike price option at a 20% tax back rate, yielded 220k to the partnership.  If the tax rate had been bid up to 30%, the partnership would receive 290k.  That 290k (5.8M equivalent communal equity) can be re-auctioned off at a starting bid tax-back rate of 10%.  If a partner took the opportunity to sell his share at 10% tax back, he would receive 271k (5.42M communal equity), while partnership received 29k but reduced the number of partners by one.  So, if the commune is truly worth the 10M a new partner was willing to pay for it, reducing the number of partners from 20 to 19 (as a result of the re-auction) is worth 26,315 to each partner (as compared to not offering the re-auction and keeping 290k being only worth 14,500 to each partner).

Liquidity in the shares of private companies and communes is typically the largest concern for investing in such enterprises.  The right to a tax-back cashing out option for owners and option holders as well as the original partnership abandonment right (restricted loans ("put" options) from partner contributions into the commune) provides some ease in leaving the commune.  Although partners leaving rarely improves the health of the commune, the ease of exit makes entering more appealing.  Its the same principle as retailers offering money back guarantees.  Its done to increase sales despite its costs.  

Communal equity principles prevent the most desperate shareholder/partner to sell his share below the median democratically set price by all partners.  The tax-back flipping right though basically achieves the same result. There is a transfer of share from one seller to one buyer, the seller receives the amount he was willing to sell for, the buyer pays the median communal equity setting, and the commune pockets the difference.  In the case of re-auctions the commune uses sales proceeds to buy out one partner and retiring the share without having to raise more funds.

Another more straightforward means for natural governed and financed communes to provide liquidity (the opportunity for partners to sell their share) is to vote on a purchase price (determined by median amount - similar process as selling shares, or a vote on accepting the best offer from an existing partner), and have a transaction contingent upon regular natural finance project funding being met with a reasonable interest cap.  Those partners capable and motivated in increasing their share of the commune can individually add significantly to the funding pool available for repurchases.  Even if the funding for share repurchases is uneven among partners, it is still a rational choice for one partner to fund it all if he believes communal equity will increase, as he would profit from the interest on funding as well as share price appreciation.

Monday, June 27, 2011

Communal equity clarified - Restricted loans as equity

Communal equity accounting deals with how to split equity ownership of an institution with new equal partners, and how to facilitate attracting new communal partners who may lack the financial resources to buy an equal share.

This is another revision of communal equity concepts.  The last version was more complicated than it really needed.  It used restricted loans much more heavily than this now preferred version.  Here is the simpler and fair version.

The first 2 partners in an egalitarian/communal partnership set the partnership equity value by market transaction (mutual agreement).  All communal equity trades are transactions amongst partners.  So if there was originally one owner of an enterprise, the 2nd partner can make a direct payment to the first partner, for what amounts to 50% of the equity.  If both partners agree the company is worth $2M in communal equity (no partnership is formed if they cannot agree on value of communal equity).    The second partner owes $1M to first partner, and 50% of the ownership is transferred from 1st to 2nd partner.  

Mostly relevant for simplifying transactions among a large number of partners, we give the new partner the right to declare any amount up to the 1M he has paid (limit is because it ensures the first partner does not need more funds), as an additional contribution to the company to be made by each partner.  If the new partner decides that each should add 1M to the company, then a company that was worth an agreed 2M is now worth 4M with either an extra 2M in cash or 2M less in debt.  We can create slightly more flexibility through instead of a 4M company, we give each partner in exchange for their 1M, a restricted loan, and though the partners thus have 2M worth of total securities, the company itself is worth 2M (still 4M total).  The general reason for this mechanism is to provide additional rewards to compensate the risk to partners of investing capital behind the company's main natural finance loan queues.  

Natural finance investing at its core is debt made through queued soft loans which have no fixed payment terms, and are repaid either through organic company surpluses, or bought out by anyone willing to offer a lower interest rate loan than the company's average interest rate owing.  When a soft loan is repaid, the investor has the option to reinvest/rollover the loan at the new lower natural interest rate, and so many investors can be repaid in a fraction of a second as a result of a single new investor buying in.  Restricted soft loans are created when funds are invested into the commune.  Restricted soft loans are NEVER repaid.  They become unrestricted (become regular soft loans queued to be repaid) when a partner abandons his share.  Restricted loans stay at the back of the repayment queue until they become unrestricted.

The typical reason to have partners contribute additional capital is either to pay down debt or create some working capital (fund day to day operations).  If there was no debt (and no cash), then the partners could use the cash they just added to the company to pay themselves each a 1M dividend.  Technically, this would make the company worth 0, but it is actually worth something between 0 and 2M still.  It is worth close to 0 because what was worth 2M now has no cash and an additional 2M in restricted loans, but it is worth close to 2M because those loans are not repayable (yet), and what was worth 2M with no cash and no repayable debt should still be worth close to 2M.  A few seconds later, one of the partners may quit (perhaps in confusion) by abandoning his share.  This is the event that causes the quitting partner's restricted loan to become unrestricted, and be at the head of the repayment queue.  If the new partner quit, the history had him pay 2M into the company, receive 1M in cash dividend, and now has a 1M to be repaid as quickly as possible from revenue.  The original partner started with a company worth 2M, received 1M cash, and has a company worth 1M with a 1M@0% loan to pay.

Restricted soft loans could earn a small amount of interest (and more easily if interest begins at the time the loan becomes unrestricted).  But I'll show later that a 0% interest rate should be high enough to attract partners.  Restricted loans become unrestricted when a partner owning them abandons or sells his partnership share.  When a partner abandons his share, he gives up voting rights, and allows the organization to terminate any contracts it has with him.

Compared to regular common equity, restricted loans are extremely similar, but have the advantage for the shareholder of  the additional option of abandoning the share and converting it into debt securities.  For private corporations, this option can be extremely valuable since it can be difficult to sell/liquidate partnership shares otherwise, and its value increases whenever a commune obtains a large number of partners. For general debt holders, offering restricted loans to partners is an incentive for cash inflow into the organization (through reinvestment of partner proceeds in new partner transactions) that can be used to pay off their debt, and so substantially advantages them as well.  Furthermore, it is possible for someone willing to invest a lot in the company, and one of the main reasons in providing new partners with the right to demand reinvestment of share proceeds,  to first buy soft loans at a relatively high interest rate, then buy a share with a maximum partner reinvestment condition, so that the company's natural/fair interest rate goes down, and they enjoy an attractive, better than market, return until sufficient new investors come to buy them out.

The argument for 0% on restricted loans is that first in the case of a no-debt company, putting in 2M capital, and then withdrawing it immediately as a dividend gives each partner a 1M restricted loan for free.  So no reason to provide them any interest on top of that perk.  In the case of a company that has say 4M in debt at an average (natural) interest rate of 12%, then putting in 2M in capital not only reduces debt by 2M and save $240k in accrued annual interest, but reducing debt would likely reduce the company's natural interest rate to say 9%.  So there is an additional savings of 60k per year or 3% on the remaining 2M of debt.  Therefore, with a 0% restricted loan investment, the partners are actually earning 15% return on their 2M reinvested.  An extra 300k per year in annual (profits) expense savings can typically be worth over 3M in additional communal equity.  So a 2M company that has 4M debt and has 2M infused into it (without restricted loan) would grow in value by 2+3=5M to a total of 7M.  A very substantial return to each partner's 1M investment.

Keep in mind that there is little substantial difference in communal equity valuation between a company whose debt is reduced by 2M, and one with debt replaced by 2M of non-repayable 0% accruing debt.  To the partners, whether they own a 7M company or a 5M company with 2M total restricted loans is comparatively indifferent.  But considering that the 2M of debt is not currently repayable and accrues 0% interest, the 5M accounting value company should be worth close to 7M.  If IBM announced tomorrow that its executives have received indefinite put options entitling them to sell their shares for well below market value, there would likely be no noticeable market reaction to the stock because the stock trades higher and the likelihood of the options triggering is low.  Restricted loans could be implemented as off-balance sheet conditional promises, and so its probably fair to value them as such.

There are 2 basic scenarios that increase the risk of a partner abandoning his share.  1.  If the company does poorly, and 2. If the commune grows in its number of partners faster than it grows in value.  A partnership worth 50M in communal equity with 50 partners is worth 1M per share.  Natural governance (democratic) principles don't take account any seniority among partners in deciding what positions or offices they hold, but partners who hold restricted loans have the power to threaten abandoning their share if they are unable to have a suitable duties.

When an opportunity to have a 3rd partner join the commune arises, mutual negotiated agreement is still possible, but for the 101st partner, a streamlined procedure is helpful.  Some partners would prefer that no additional partners be allowed to join, while others would welcome being paid, and welcome the additional creative energy that could help further increase the value of the partnership.  If every partner states their perceived value of communal equity, then the median of all partner stated values determines the buy-in price.  The median represents the democratically set (by definition of 50th percentile) value for the common offer price.  It would be the appropriate way to decide what to sell the entire company for, and so it is appropriate way to determine what to sell a fraction of it for.

If both partners agree that the communal equity is valued at 3M, then a 3rd partner is required (if he agrees to buy) to pay 1M to join.  Each of the first 2 partners would receive 500k cash.  The 3rd partner can  demand that all 3 partners invest up to 500k each in restricted loans into the company.  The general formula for Nth partner joining the commune is that he pays (1/n)th of the communal equity value, and those proceeds are split evenly among the (n-1) existing partners.

One difference between communal equity and common shares is that a transaction to sell common shares is made with the seller who is willing to accept the least.  While communal equity is transacted at the median offer of sellers.  There is actually a strong rationale to forbid the personal liberty of a communal partner directly selling his partnership share to a buyer privately.  First, there is a difficult integrity issue if a buyer approaches the commune to buy in, but is then approached by individual partners who try to outbid each other to sell their share for less.  Buyers buy in at a median offer price, and it would be a disservice to them if when selling they would need to out-offer all the other partners, or if new partners are never brought into the commune because one partner is always able to sell out at lower than median offer price.  Natural Financed private corporations enjoy software platforms that provides its continuous financial health to potential investors and partners, and that can make these private corporations have greater investment liquidity than public corporations.  So if the tools to attract partners are funded by the commune, and expected to be the main financial marketing mechanism, individual partners shouldn't be able to "pilfer" investors to the commune by underselling it, in the same way they shouldn't arbitrage employee product discounts to go resell to the enterprise's customers.  The right to abandon the share and receive compensation for it gives individual partners the ease of secession from the commune, without needing to resort to the right to sell their share individually. (Though this strength is much truer in the last version of communal equity which relied on creating more restricted loans with each new partner, and perhaps advantaged old partners somewhat.)  An individual partner can also secede from the commune by proposing that the commune buy back his share at below the median/market rate, and do so if a democratic majority of partners accepts the proposal.  

Natural Financed Egalitarian Partnerships can achieve higher market capitalization than standard corporations (median offer is always higher than lowest offer). They can raise funds continuously.  Issuing more shares never dilutes existing shareholders without directly compensating them for the dilution.  Insider information becomes a relatively irrelevant factor in the market because the communal entry price is the result of the median value of all sellers, who should all be insiders.  Capital contributing shareholders receive the advantage of an option to convert to debt holders, and the company/creditors gain investment resources through reinvestment of communal entry contributions by existing partners.  Egalitarian partnerships can also use natural governance principles which further enhances value over traditional corporations.


Senior Partners are those partners who have fully paid their partnerhsip share, as has been discussed so far. Junior partners are those who have not fully paid for their partnership share.  Many people able to contribute creative or productive energy to the enterprise would be unable to afford their share to join the commune.  The answer is simply a payment plan.  Junior partners would be accepted because of their creative/productive potential, and would be expected to make payments for their share through a portion of their employment benefits.  Junior partners are charged interest (5%) on the unpaid portion of their communal share, that interest is withdrawn from the paid portion of their share.  They have the right to abandon their share without penalty, in which case they no longer owe the unpaid portion of their share, but lose any paid portion.  Partner capital contributions made by senior partners, and which generally cannot be matched by Junior partners increase the unpaid portion of  the junior partner's share. Contributions from future partner buy-ins reduce the unpaid portion of junior partner shares.

In our example, if a 4th potential partner is a junior partner employee expected to contribute 30k per year to his share, then a 1M purchase price (4M communal equity value) with 50k per year in interest means that he would accumulate negative equity if no new partners came in or communal equity didn't increase.  Junior partners who abandon their share never owe anything if their paid up capital is negative.  After 100 partners, the junior partner would owe less than 40k for his complete share originally worth 1M. If communal equity were to increase to 10M, then the 101st potential partner would buy in at 100k with 1k going to each partner.  When junior partners join, any payments they make go evenly to all other partners.  Junior partners get accepted with negotiated payment rates as a percentage of employment benefits, and a lower flat rate should they no longer receive employment benefits from the organization.  Junior partners retain the right to their partnership share as long as they meet the payment requirements.  Junior partners have a full vote in setting communal equity of the organization, but may have fractional votes for other communal decisions.  In our example of 4 partners with 1 junior partner making 30k contributions per year, each senior partner would gain 7.5k (likely in interest bearing deferred compensation queued soft loans), while the junior partner would reduce his unpaid capital by 30k.

Junior partners get a similar benefit as no-money-down real-estate purchases in that they can abandon at little to no risk if their asset value does not increase in price.  In the above example 30k annual payments could be insufficient to meet the interest on the unpaid balance, and so they could accumulate negative equity quickly.  They also receive an effective-call option on the communal equity with strike price equal to the value at buy-in time that is valid as long as they meet agreed payment terms, and whose premiums is the 5% interest on unpaid capital.  This is substantial value for junior partners.  The senior partners do eventually receive the purchase price and collect the interest premiums, and if the junior partner abandons his share, the senior partners will have kept gains from the interest premiums, while the junior partner likely walks away with nothing, even though his interest payments were made with likely fake salary perks and so unlikely that he risked anything out of pocket.

A junior partnership for new employees is both too good of a deal for a brand new employee and too risky to get pushed out of a job that you were paid in large part with the promise of a future share.  If the commune has too few partners at the time the junior share is issued, it could take 10-30 years to pay off if new senior partners don't buy in.  If many partners do buy in, and the company grows moderately, the junior partner becomes extremely rich.  For example, if the communal equity doubles and the number of partners also doubles in a few years, then the junior partner could have paid for his share entirely through the contributions of new partners, and he would still own a percentage of the company that is worth what it was when he was awarded his junior share.  For these reasons, the recommended alternative for instilling a sense of ownership in employees are Deposit Options.  These can fit into a junior partnership being awarded a few years after an employee starts.

More partners allows lower buy-in value per partner which makes joining the commune available to more people, and so a higher likelihood that some people are willing to accept higher proposed communal equity value.  Its conceivable, as part of negotiation with junior partners that the commune provide another loan to the junior partner to serve as "down-payment" for his share in order to transfer more risk towards the junior partner, but this is only effective if the junior partner would have an ability/willingness to pay if he abandons his share.  Junior partnerships can also be offered to suppliers, customers, and lenders.  While 5% is a guideline interest rate to charge, it is somewhat negotiable.  Offering junior partnerships to speculators at higher rates should be discouraged, as requiring them to borrow funds elsewhere should be a suitable alternative.  And Deposit-options are almost always preferred to junior partnership offers made too early in the relationship.

Friday, June 24, 2011

Deposit Options - A security to facilitate communes

When you make an accepted offer to purchase a home, it is customary to include a deposit upon acceptance, and you pay the remaining balance on the closing date of the purchase.  Typically, if you walk away from the purchase there are no legal repercussions other than the seller keeping both your deposit and his home.

I'm introducing the definition of a Deposit Option as a call option where the premium paid for the option is deducted from the strike price on exercise.  A regular call option is the right for the buyer to buy a security or property at a specified price before a specified date.  The price paid for a regular call option does not affect the amount due.  A deposit option is extremely similar to the good faith deposit when purchasing a home, except that it caries no obligation whatsoever to follow through and purchase the property.

A deposit option can have applications as long term publicly traded stock options as well.  If Company X's current share market price is $100, a deposit option to buy X for $150 in 2 years could be traded for say $20.  This gives the buyer the right to pay an additional $130 for the stock within 2 years.  The buyer of this option can resell it anytime as a regular call option with $130 strike price, since $130 is the break even point determining the buyer's choice to exercise the option.  There is a bi-directional convertibility between regular call options and deposit options, which I will only briefly mention that this means we can use standard option valuation models, and deposit options can offer the seller higher initial premiums for options "in or near the money".

My rationale for introducing the concept of a deposit option is in its use for making deposits on securities generally, but also allowing for renewable options and modifications to strike price.  Communal Equity Principles determine financial processes for equal partners to earn their equal share.  There is a distinction in rights between Senior Partners (those who have fully paid/earned their share) and Junior partners (those who have a contractual path to obtain senior partner status).  The concept of fostering junior partners is desirable primarily to encourage workers (without the capital to buy share outright) to work in the best interest of the commune and thus the best interest of their eventual equal share.

While the original "payment plan" described for junior partners was focused on potentially interest bearing loans on the unpaid balance of a fixed initial buying price, but there are several issues with that approach.  It can be too good of a deal to give junior partners today's buy-in price while giving them 10 years to pay it off. When new senior partners buy into the commune, they have the option of asking all partners to put some portion of the proceeds the new partner pays them back into the company.  Doing so, substantially benefits the junior partner's share because it increases the value of the company by the amount of proceeds invested in it.  There is also an issue of the junior partner potentially losing his share by losing his employment and potentially forced out for the purpose.

A better payment plan for Junior partners is deposit options.  Ones where the strike price adjusts based on capital (equity) inflows and dividends, and options that can be transferred/sold if desired or needed.  As options, they can be offered to any investor.  Not just workers.  But workers get the advantage of being paid enough to cover the option premium(s).

A Communal Equity Option is a deposit option to buy one equal share of a commune at a specified communal equity value by a specific time.  The striking difference between communal options and regular equity options is that the total number of shareholders and therefore price per share at the time of exercise is unknown.  The option strike price is based on the total value of the commune and divided by actual number of partners to determine share price.  They are implemented as deposit options.  The communal equity strike price is adjusted up for partner capital contributions and down for dividends paid out. The other striking novelty of a communal equity option is that the sellers are the communal partnership of owners in equal portion.  The option premium paid goes directly to owners in equal share.

Long term Communal Equity Options can be priced in installments.  This makes each installment an option to renew the option.  The obvious application of an option installment plan is for workers who lack capital but can be given a salary bonus that covers the option premiums.  Pricing for employee options must be model-based and based on the democratically set communal equity value, and with approval of preferably a natural finance comptroller or an elected options policy governor.

Another very useful application of Communal equity options is that of an angel investor role.  Having the option to buy a share of the company in the future, while paying a relatively small monthly option premium to the founders allows for founders to draw an equivalent to a salary in collected option premiums, and does so off-balance-sheet to the company, and thus doesn't saddle the startup with as much debt compared to an investment in the company followed by drawing salaries from the company.  For the angel investor, many smaller option premiums gives the opportunity to walk away if sufficient progress is not achieved.  Since angel investor options involve cash payments between parties (worker arrangements can involve accounting entries that create loans from premiums) there is no need to place any model or comptrollership limits on the amount of the premiums.

As an example angel investor scenario, A very early stage startup might have communal equity value of $50k.  An angel investor might be offered a 3M strike option with 5 year term for 2k per month in premium or 4M strike with 10 year term for 3k per month in premiums.  Conceptually, even both options can be offered on an either/or basis (only one can be exercised) for a premium of 3.1k per month.  The first option would give the angel investor the right to buy a share, with circumstances of say 5 years later there are 4 partners in the commune, for 600K less the options premiums paid (60 * 2k) of 120k = 480K.  So, buying a share is attractive to the Angel investor if he believes the commune is worth 2.4M or more.  The more partners there are at the time of the exercise, the more valuable the option is to the buyer because the cost of one share is smaller, but the deduction for paid premiums is the same regardless of the size of the partnership.  Attracting more partners to the commune is generally in the interest of existing partners as it both allows them to partially cash out, and brings additional resources to help make the commune grow.  Option premium installments have the advantage to the buyer of reducing the effective strike price with each installment, and the advantage to partners of providing steady cashflow.

Communal options are supplementary alternatives to the Junior partnership share that was intended for workers.  The Junior Partnership arrangement of buying a share with secured loan is still possible, but the encouraged arrangement is to offer communal options to employees, and let the employees exercise those options when appropriate with the commune lending them the additional purchase funds they need.  Thus turning a communal option into a junior partnership share.  The advantage to the employee is that his option is sellable/transferable, and the advantage to the commune is that the sales price can be estimated to be the value in 2 or 5 or 10 years rather than current equity value, and the paid in option premiums serve the function of a down payment (vested interest) on the junior partnership when exercised, and so a reasonable share of both risk and reward compared to senior partners.

The most important difference between a Junior partnership (part) share and a communal purchase option is that no voting authority occurs until the option is exercised.  Holding the option still provides an incentive for enhancing communal value, and unlike traditional stock options, the option holder is insulated from a high dividend payout policy.

An option does carry the risk to the buyer that it will expire worthless.  There might be an appearance of a slight bias in motivation by the partners to not be too successful.  Because a communal equity option is essentially renewable on every installment, there is a clear incentive for the partners to continue progress on the enterprise in order to continue enjoying receiving option premiums.  Even if there is a 3M option on the commune, attracting partners at a 10M valuation before the option is exercised, both lowers the cost of exercising the option to the buyer and reduces the share of the company given up by the existing partners.  So, if the true value of the commune is 10M and there are 19 partners, the optionholder can acquire a share for 150k (less premiums already paid) instead of 500k.  The 350k "lost" by doing too well is much less than the share value remaining and cashed out by the first few partners as a result of obtaining additional partners near 10M in communal equity buy-ins.

On a related note, before your startup grows to be worth $10M, it will at one point along the way be worth $3M, and $3.5M.  At that time, an option holder may very well want to exercise his option before it expires because 1.  It removes his obligation to keep paying option renewal premium installments, and 2.  He obtains voting rights, and 3. If he is hopeful about the prospects of the company, he can gain a much larger share of the company if he would be, say, the 5th  partner today instead of the 20th or 100th partner years from now when the option expires.  So 1/20th of 10M is 500k, and a 350k profit on the option, but buying 1/5th for 600k, would make that 5th worth 2M when company is worth 10M, and so 1.4M profit.

A note about employee/management options in traditional corporate structures is that they have a corrupting influence as a result of no adjustments for dividends and share capital infusion.  AAPL for instance has over $65B in cash, and no real use for it.  But if it paid that cash as dividends, it would hurt those employees who have stock options even if the dividend would be in shareholder interests.  Though most share capital infusions tend to be made at a fair price, excessive management options can dilute shareholders and fellow option holders.  The significant harm of unadjusted options though is the dividend reluctance it causes management.  In the case of even successful companies such as AAPL, it makes it more likely that it will go bankrupt before paying back owners its current valuation.

There are also significant tax advantages to options in Canada and manywhere else.  Options have an electable treatment as to whether they are capital gains or income.  Thus partners can treat option premiums received them as capital reduction to their share value (only taxed when share is sold).  Angel investors can treat option premiums as an income expense, and though likely an un-recommendable stretch, employees could treat their paid option premiums as an offsetting employment expense.