compensation experts have put together a checklist of the ten most
important questions you should be able to answer about your stock
options. Use this checklist as you prepare your research for a salary
negotiation, or at your next performance review, or when you are
in line for a promotion. Some of these questions are essential to
understanding the value of your stock options award, and others
simply help explain the implications of certain events or situations.
be surprised if you have options now and can't answer some of these
questions - they're not all obvious, even to people who have received
stock options before.
answers provided here are relevant for people from the United States.
If you are not from the United States, the tax information and some
of the trends discussed may not be relevant to your country.
ten most important questions about your stock options are as follows.
type of options have you been offered?
many options do you get?
many shares in the company are outstanding and how many have
is your strike price?
liquid are your options, or how liquid will they be?
is the vesting schedule for your shares?
you get accelerated vesting if your company is acquired or
merges with another company?
long must you hold your shares after an IPO, merger, or acquisition?
you exercise your options, do you need to pay with cash, or
will the company float you the exercise price?
kinds of statements and forms do you get or do you need to
1. What type of options have you been offered? In
the United States, there are essentially two types of stock options:
incentive stock options (ISOs) and nonqualified stock
options (NQSOs). The primary difference between the two with
respect to the option holder is the tax treatment when the option
you exercise ISOs, you do not normally have to pay any taxes (although
there is a chance you may be required to pay an alternative minimum
tax if your gain is large enough and/or certain other circumstances
apply). You will eventually have to pay taxes on this gain, but
not until you sell the stock, at which time you will pay capital
gains taxes (the lesser of your marginal rate or 20 percent) on
the total gain - the difference between the amount you paid to exercise
the option and the amount for which you ultimately sold the stock.
though, you must hold the stock for at least a year after you exercise
the option to protect this tax break. Otherwise your incentive stock
option will automatically become a nonqualified stock option and
you will have to pay ordinary income tax.
you exercise nonqualified stock options, you are required to pay
ordinary income taxes on your gain as of the time you exercise the
option. This tax is based on your marginal tax rate (between 15
and 39.6 percent). When you eventually sell the stock, you will
have to pay capital gains taxes (the lesser of your marginal rate
and 20 percent) on the gain you realize between the market price
on the day you exercise and the market price on the day you sell
Companies offer nonqualified stock options for a few reasons. There
are a number of restrictions on when and how many incentive stock
options a company can grant, as well as the conditions for those
options. For example, if the company issues stock options with an
exercise price below the actual share price, those options cannot
be incentive stock options. Also, the company receives a tax deduction
for nonqualified stock options, but not for incentive stock options.
The deduction helps reduce the company's tax burden and therefore
can help increase the value of the stock.
How many options do you get?
The number of stock options you receive is a function of several
variables. Option grant sizes depend on your job, the frequency
of the grants, the industry, the company's pay philosophy, the company's
size, the company's maturity, and other factors. In a high-tech
startup, for example, the grant you receive is generally much larger
as a percent of the company's total shares outstanding than a grant
you would receive from a more mature, established company. But often
when a company is awarding a large number of shares, it is because
there is more risk associated with them.
People often have a hard time comparing option grants from various
job offers. Don't focus solely on the number of shares you're being
granted. Try to keep in mind their potential value to you and the
likelihood that they'll achieve that value. For a startup, your
options may have an exercise price of $5 or $1 or even 5 cents per
share, but at some point a year or two from now, those shares could
be worth $50 or $20 or $10 or even nothing. Presumably less risky
are options from mature companies that provide more stability but
also less chance of a "home run." In these companies,
look at the exercise price of the options and how you think the
stock will perform over some period of time. And remember, a 10
percent increase in a $50 stock is worth $5, whereas a 10 percent
increase in a $20 stock is worth $2.
How many shares in the company are outstanding and how many have
The number of shares outstanding is an important issue if your company
is a startup, because it is important to gauge your option shares
as a potential ownership percentage of the company. For most people,
this percent will be very small - often less than half a percent.
It is also important to know the number of shares approved but not
Although this number is most relevant to startups, it is relevant
to everyone because approved but unissued shares dilute everyone's
ownership. If the number is large, it could be an issue. Dilution
means each share becomes worth less because there are more shares
that must make up the same total value.
What is your strike price?
The strike price of an option - also called the "exercise price"
or "purchase price" - is often the price of a share of stock on
the day the option is granted. It does not have to be the share
price, but it often is. This is the price you will eventually pay
to exercise your option and buy the stock.
an option is granted above or below the stock price on the day of
the grant, it is called a "premium option" or a "discounted option,"
respectively. Discounted options cannot be incentive stock options.
Companies that are not publicly traded (traded on a stock market
or "over the counter") may still have stock options, which do have
a stock value. The fair market value of a share of stock in one
of these companies is normally determined by a formula, by the board
of directors, or by an independent valuation of the company. If
you are working at one of these companies, you should ask how the
share price is determined and how often. This will help you understand
what your options are worth.
you are negotiating, don't be surprised if the company representative
tells you they cannot award you options below the current stock
price. Although it is legal to do, and many plans allow for it,
many companies have the policy of not awarding options below fair
market value and they don't want to set a precedent. The number
of shares you receive and the vesting are typically easier to negotiate
than the strike price.
How liquid are your options, or how liquid will they be? Here, liquidity refers to how easy it is to exercise your stock
options and to sell the shares. The primary issue here is whether
your company's stock is publicly traded. If so, there are thousands
of investors looking to buy or sell those shares on any given day,
so the market for those shares is said to be liquid.
other companies, including partnerships, closely held companies,
and privately held companies, normally have restrictions on whom
you can sell your stock to. Often it is only to one of the existing
shareholders, and it may be at a formula or fixed price.
A stock that is illiquid can still be quite valuable. Many companies
with low valuations and illiquid stocks over the past few years
have either been acquired or gone public, greatly increasing the
value and/or the liquidity for the option holders. These types of
"liquidity events" are never guaranteed, but they are
What is the vesting schedule for your shares?
Vesting is the right you earn to the options you have been granted.
Vesting normally takes place over time, but may also be earned based
on certain performance measures. The concept is basically the same
as vesting in a retirement plan. You are awarded a benefit - in
this case, stock options. Over some period of time, you earn the
right to keep them. If you leave the company before that time has
passed, you forfeit the unvested options. The current trend is for
options to vest in monthly, quarterly, or annual increments over
three to five years. For example, your options may vest 20 percent
per year over five years, or they may vest 2.78 percent per month
for 3 years (36 months).
Vesting seems to be trending toward shorter schedules with smaller
increments (e.g., monthly over 3 years rather than annually over
5 years). Companies try to keep consistent option terms for people
at similar levels, but vesting terms for stock options are sometimes
negotiable, especially special grants for new hires and special
recognition awards. Once an option is vested, it's yours regardless
of when or why you leave the company. So the faster your options
vest, the greater your flexibility.
Will you get accelerated vesting if your company is acquired or
merges with another company? Sometimes, upon certain "changes in control" of a company, stock
option vesting schedules accelerate partially or fully as a reward
to the employees for increasing the value of the company, or as
protection against future unknowns. Usually these events do not
trigger full vesting, because the unvested options are one of the
ways the new company has of keeping the employees it needs. After
all, often the employees are one important reason for the merger
companies also provide an increase in vesting at the IPO, but that
is normally a partial increase rather than full immediate vesting.
It is important to know whether you get accelerated vesting so that
you fully understand the value of your options. But unless you are
a senior executive or a person with a very important and hard-to-replace
skill, it is difficult to negotiate any acceleration above and beyond
the plan's stated terms.
How long must you hold your shares after an IPO, a merger, or an
If your company merges or is acquired, or if it goes public, you
may not be able to sell your shares right away. The length of time
you must hold your shares after an IPO or merger depends on the
SEC (Securities and Exchange Commission) and individual company
restrictions. Review your option agreement, plan documents, and
any pre-IPO or premerger communications for descriptions of any
holding period or lockout period.
Although you can't change the lockout period, you can use it
to plan how you will use the proceeds from any sale of stock. Note
that the price of a company's stock sometimes decreases on or after
the day a lockout period ends, as employees sell their shares in
large numbers. If you want to sell after a lockout period, and the
price decreases, you might benefit from waiting a little longer
until it stabilizes, provided the stock is performing well in other
When you exercise your options, do you need to pay with cash, or
will the company float you the exercise price?
Depending on the company you work for and the terms of the stock
option plan, you may be able to exercise your options in one of
three ways: by paying the exercise price out of your own checking
account; by borrowing the money in a bridge loan from your company;
or by completing a cashless transaction that allows you to receive
the net number of shares you would end up with had you borrowed
the money to exercise the options and sold just enough shares to
pay back the borrowed money. For the second and third alternatives,
you should know whether any taxes you owe can be paid from the loan
or cashless exercise.
If you must pay the cost of the exercise, you may need a significant
amount of cash. To preserve the favorable accounting treatment of
any incentive stock options you exercise, you will not be able to
sell the stock for a full year. Well before you exercise your options,
you should consider contacting a financial advisor to determine
the best approach for given your financial situation.
What kinds of statements and forms do you get or do you need to
Some companies provide a regular statement or even a daily update
on your company intranet summarizing your holdings, what's vested
and what's not, the value of each based on the current stock price,
and perhaps even an indication of the after-tax gain. Other companies
give only an initial option agreement with no updates until the
option term is about to expire or you are about to leave the company.
Whether the company provides updates for you or not, be sure you
receive, in writing, a dated statement from the company that tells
you how many options you have been awarded, the exercise price,
the vesting schedule, the expiration date, exercise alternatives,
terms for changes of control, and terms for adjusting based on reorganization.
last issue is important because if the company's stock splits or
mergers with another company's stock, your stock options should
be adjusted accordingly to make sure your financial position is
sure to keep all option agreements. These are legal contracts, and
should there ever be an issue over what you've been promised, that
statement will help protect your rights.