Stock Options and Equity Compensation: Understanding Your Startup Stake
Stock options are a form of equity compensation commonly offered by startups and tech companies that give employees the right (but not obligation) to purchase company shares at a predetermined price (strike price) after a vesting period.
Unlike restricted stock units (RSUs) which are actual shares granted directly, options require you to pay the strike price to acquire shares—but when structured well, the strike price is far below the current market value, creating immediate profit.
A typical startup offer might include 10,000 options with a $1 strike price, vesting over 4 years with a 1-year cliff (25% vest after year 1, then monthly vesting for remaining 75%).
If the company goes public or is acquired at $20 per share, those options are worth $190,000 in profit ($20 market price - $1 strike price = $19 profit per share × 10,000 shares).
Understanding vesting schedules is critical: the 1-year cliff means zero options vest if you leave before 12 months, protecting companies from employees who leave immediately.
After the cliff, options typically vest monthly or quarterly.
Acceleration clauses can vest options faster in certain events—single-trigger acceleration vests all options upon acquisition (good for employees but makes the company less attractive to acquirers), while double-trigger acceleration requires both acquisition AND termination (more common).
Early exercise provisions allow exercising options before they vest, potentially providing significant tax advantages by starting the capital gains holding period earlier and locking in lower strike prices.
The key financial considerations include: current valuation (options in a $1 billion company are more likely to pay out than a struggling startup), dilution (your percentage ownership decreases in funding rounds), strike price vs.
409A valuation (options are only valuable if strike < market price), tax treatment (ISOs vs.
NSOs have very different tax implications), and exercise costs (you need capital to buy the shares).
Tax strategy is complex: Incentive Stock Options (ISOs) can qualify for preferential capital gains treatment if held properly but trigger AMT; Non-Qualified Stock Options (NSOs) are taxed as ordinary income on exercise.
Many employees make mistakes by: not exercising before expiration (typically 90 days after leaving the company), exercising too early and losing money if the company fails, or not understanding tax consequences.
The 83(b) election for early exercise can save enormous taxes but is irrevocable and must be filed within 30 days.