Startup stock options

startup-stock-options-explained
Startup stock options are a type of equity-based incentive provided by founders to their employees.

What are Startup Stock Options?

Startup stock options are a type of equity compensation given to employees, advisors, and occasionally contractors in lieu of or in addition to a regular salary. They provide the option holder the right to buy shares of the company at a predetermined price in the future.

Why do Startups Use Stock Options?

Startups often have limited cash flow but need top-tier talent to grow. Offering stock options allows them to:

  • Conserve cash for business operations.
  • Attract and retain key talent.
  • Align employees’ interests with the company’s success.

What are the Different Types of Startup Stock Options?

There are primarily two:

  • Incentive Stock Options (ISOs): Generally offered to employees and come with tax benefits when held for a certain period.
  • Non-Qualified Stock Options (NSOs): Can be given to anyone, including contractors and board members. They don’t offer the same tax benefits as ISOs.

Startup Stock Options for Advisors

Advisors can be invaluable to startups, providing expertise and networks. In recognition, startups may offer them stock options, called advisory shares typically in smaller percentages than full-time employees, with unique vesting schedules.

How Do Stock Options Work?

Stock options grant the recipient the right to buy shares at a set “strike price.” If the company’s value rises above this price, the holder can buy shares at the strike price and then sell them at the current market value, pocketing the difference.

When is the Right Time to Set Up an Employee Stock Option Plan?

Startups should consider setting up an ESOP (Employee Stock Option Plan) once they:

  • Have a clear business model and growth strategy.
  • Start hiring key talent that they wish to retain long term.
  • Receive funding and can afford the administrative costs.

What Should I Look Out for in a Startup Stock Option Agreement?

  • Vesting Schedule: How and when the options become exercisable.
  • Exercise Price: The price at which you can buy shares.
  • Total Options Granted: Total number of shares you can buy.
  • Expiration Date: The last date by which you must exercise your options.

How Do Startups Negotiate Stock Options? How Much Should I Expect to Get?

Negotiation depends on the role, stage of the company, and the individual’s contribution. Typically:

  • Early employees might get 1-5%.
  • Key executives could negotiate for more.
  • Mid-to-late employees might see <1%.

What to Negotiate for in Startup Stock Options?

  • Number of Options: The amount of stock options granted.
  • Vesting Acceleration: Conditions under which vesting might speed up.
  • Exercise Window Post-Termination: Time you have to exercise after leaving the company.

What are the Important Words in Startup Stock Options?

  • Vesting: The process of gaining the right to exercise options.
  • Cliff: A period before any stock options vest.
  • Exercise: Act of purchasing shares at the strike price.
  • Strike Price: Predetermined price at which options can be exercised.

How Does Vesting Work?

Vesting schedules determine when you can exercise options. Commonly, there’s a one-year cliff, followed by monthly or quarterly vesting for a total of four years.

How Do I Turn My Stock Options into Cash?

To convert stock options to cash:

  1. Exercise the options by buying shares at the strike price.
  2. Sell those shares in the open market, if possible, or during a company liquidity event.

What Does it Mean to Exercise Your Stock Options?

Exercising means buying shares of the company at the predetermined strike price. Once exercised, they become actual shares that you own.

What Happens to My Options if the Startup I Work for Goes Public?

If a startup goes public, your vested options can be exercised and then sold on the public market, potentially leading to significant financial gains. Unvested options might continue to vest as per the schedule or might have an accelerated vesting.

In conclusion, startup stock options can be a lucrative compensation component, but they come with complexities. It’s vital to understand your agreement and consult financial or legal professionals as needed.

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