employee stock options
Stock options give the right to the employee to purchase company stock at some future date. For the more technically inclined, employee stock options are a subset of generic stock options that are actually call options where the underlying asset is the stock of the employing company. Because call options are less expensive to purchase than actual stock and because early-stage companies are often worth far less when they are new than they will be when they "grow up," stock options can be a relatively inexpensive way for the company to incent employees. From the employees perspective, stock options are inexpensive and can create significant wealth if the company is successful. This creates a powerful incentive for those employees with stock options to work hard to ensure that the new company is successful.
Stock options are generally part of a stock option pool that is authorized by the company's Board of Directors. Once that pool has been established, the company can grant individual option shares to optionees using a Stock Option Agreement.
Stock Option Basics
As mentioned above employee stock options are a specific form of generic stock options. General stock options give the holder the right but not the obligation to buy shares of the underlying stock at a specified share price. So, for example, if you bought a stock option (call option) for Citigroup shares, you would have the right but not the obligation to buy shares of Citigroup at any point during the lifetime of the call option at a specified price, say $10.00 / share. If a person uses her right to buy shares, she is said to "exercise" her option.
Employee Sotck Options work in a similar way. These options give the right to the user acquire stock in their employer company at any point during the lifetime of the stock option contract at a predetermined price. They are granted to the optionee using a Stock Option Agreement.
Elements of a Typical Stock Option Agreement
The Stock Option Agreement is a legal document that grants options to an optionee. A typical stock option agreement will have the folllowing elements:
- Name of the Optionee
- Address of the Optionee
- Date of Grant
- Vesting Commencement Date
- Shares Subject to the Option--this is the number of shares that the optionee can acquire through the exercise of her option
- Exercise Price--this is the price per share that the optionee will need to pay to exercise
- Total Exercise Price--this is the exercise price per share times the total number of shares subject to the option
- Expiration Date--this is the date after which the option is no longer available to the holder
- Type of Option--this generally specifies whether the option is an Incentive Stock Option or a Nonstatutory Stock Option
- Vesting Schedule--this describes the timing and rate of vesting
- Exercise Schedule--this describes the timing and rate of exercise. It is often the same as the vesting schedule though some companies allow early exercise.
- Triggers--this describes the circumstances under which the stock options may automatically vest
Types of stock options
There are two kinds of employee stock options. Please explore the links below to learn more.
- Incentive Stock Options (also sometimes called Statutory Stock Options)
- Nonstatutory Stock Options
Impact on Employees
Employee Stock Options can create powerful positive incentives for employees. First, employee stock options are generally granted to employee optionees before the company has grown so large as to become a target for acquisition or exit. Second, stock options are always less expensive than the underlying stock itself. Because of these two factors, optionees are often able to get stock at a very low price relative to what it will be if the company becomes successful. Finally, because most stock options are vested, it also provides a powerful retention tool for employees. Employees who might otherwise leave the company are incented to stay to receive additional stock-based compensation.
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