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What are stock options?

Options, grants, vesting, cliffs, more!

What are stock options?

A stock option is literally, an option for someone to purchase a share of a company at a given price. Startups often grant new employees stock options as part of their compensation.

But just because you've been granted options, you don't immediately own anything yet. You'll still have to actually buy those shares at a later date, once you've fully vested (or earned) your shares.

Strike price

The strike price is how much you'll pay for each share when you decide to exercise of buy them. This is usually less than the market value of the shares. Why? Because you only make money when you can buy low and sell at a higher price. That's how investments work.

Vesting period

Although, you'll be granted a large number of shares up front, you can't exercise or buy them until they've vested. Typically, a vesting period lasts four years, with a one year cliff. That means you'll earn your shares over four years (while you work at the company), but the one year cliff means you have to stay at least a year to earn any of your shares. This is how companies keep employees and equity from leaving too soon.

So, after you've worked at the company for a year, you'll have earned 25% of your shares, and then ever month there after, you'll earn a prorated amount.

If you leave before your first year, you get no shares. And if you leave after a year, but before the vesting period, you'll leave with some percentage.

90 day window & exercising your shares

Even if you've earned all your shares during the vesting period, you still have some decisions to make. If you leave the company, you'll typically have 90 days to decided whether or not to exercise your options and buy your shares. It's something you need to plan for in advance.

This can be a bummer, because if your shares are worth a lot of money, you'll need to come up with a lot of cash very quickly to purchase them and then pay capital gains taxes on them as well. FYI, some companies have started to change their minds about this practice, but 90 day windows are still standard.

Liquidity events

So, when can you sell your shares? Once you've had a liquidity event, like an acquisition or an IPO. When someone buys your company or you go public, that's when you can realize the value of your options and trade them on the open market.

For example, Twilio recently had a big IPO. Now their employees can exercise their shares - buying low, selling high, and pocketing the difference.

Why do stock options matter?

At an early stage company, resources, especially cash, are limited. A company might not be able to afford your full desired salary, but can offer you a larger portion of the company as compensation. If you have a tolerance for risk, you may be able to forgo some of your cash compensation in exchange for an opportunity to make even more money via options. Of course, there's no guarantee your options will make you a millionaire, so don't bet your life on them.

Calculating the value of your stock options

When discussing stock options with your boss / hiring manager, there are two things you should keep in mind

  1. What percent of the company does this represent? (calculated as # of shares granted to you / shares outstanding)
  2. How much are these worth right now?

You should definitely make sure you know how big your slice of the pie is, percentage wise. But, private company valuations aren't very reliable, so #2 isn't that important early on, but it will be in the future for liquidity events.

It's more important to think, "Do I like this product?" "What will it take for this company to succeed?" "Is the market big enough for this product that we'll grow this company to worth a lot?" You should be focused on if there's an opportunity for the value to appreciate, not if it's worth a lot right now.

Salary vs. equity

These days, the market for engineers is so strong that options are really a bonus. You should not be treat them as a replacement for cash, until you truly believe in the opportunity longterm or you're the CEO. Demand market or above-market rates for your skills!


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