Stock Options 101

03 November 2021

Stock Options 101 Pen

Stock options are becoming more common as employers seek out new ways to diversify employment offers. Although how much you get depends on seniority the option to really buy into your company and hold a little of the potential profit in your hands certainly is appealing.

However whilst options spread quickly, information does not, so we’ve put together a guide to simplify stock options for the uninitiated.

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What are stock options?

Stock options are a special type of contract. They grant the holder the right to buy or sell an asset at a set price, on or before a certain date.

 

Why do stock options matter?

Being offered stock options by an employer shows you matter for a start, as equity in the company is their most precious asset. Therefore to be offered such a perk is an extension of trust, and appreciation for your value as an equally valuable asset to the company.

Beyond the gesture, it is a great opportunity to make money by investing in your company. In a sense you are investing in yourself too, so the extra incentive is there to work as hard you can to add value to your organisation.

Stock options in a fledgling operation are particularly valuable, because despite the risks of working for a startup, if you can see the potential of the company’s vision, you get a greater slice of the pie a couple of years down the line.

Picking the right opportunity is crucial; the startup you buy into today could be the next Klarna tomorrow.

 

How do stock options work?

Acting on your right to buy or sell is known as exercising your options, although typically the holder doesn’t have any rights to buy until after their first year with the company. After this point they are usually able to buy their shares in linear portions such as 25% a year every year. This is known as vesting, the process by which an employee accrues rights to exercise their options. The one year period where the employee cannot vest their rights is called a ‘cliff’.

After four years, they may have purchased 100% of their option. Often stock options come with a ‘use-by’ date, requiring holders to exercise their rights within a set period of time, such as a ten year period. The price of stock will be fixed at a set or ‘strike’ price.

If they want to exercise their options, the holder must pay the exercise price, which is the strike price multiplied by the number of options. In return they will receive ordinary shares in the company. Depending on the contract the holder may be able to sell these shares immediately, or retain them in the hope of appreciating value.

How do stock options work in my country?

In general it is best to investigate the laws of your country, and/or the country in which you have been asked to work when considering stock options. In general however, the USA has the most progressive attitude to employee ownership.

In the USA there is no premium or tax to pay upfront on stock options unlike shares, making them risk-free for both employee and company. In Europe, option holders are often disadvantaged, needing to pay a high strike price, in addition to heavy taxation upon exercise and sale. Out of all European countries, the UK, France and Estonia are the most supportive of stock options.

 

When should I exercise my options?

If the share price of the company exceeds the strike price, then it is a great time to buy in as you are immediately making back your money. A company’s share price will be decided by the total valuation of the company, divided by the number of shares.

Exercise requires cash payment, so any decision to buy will depend on the on the holders confidence in seeing a cash return over a reasonable period of time. Any tax incurred will also influence this decision.

 

What should I be looking for in good stock options?

A good investment. That’s the first thing, is it worth my time and money? Is it a good idea? If your employer can’t sell you on that, consider looking for a new job. Transparency is also crucial, an honest company will sit you down to explain the best and worst case scenarios of holding stock options along with their Employee Stock Option Plan (ESOP) documentation.

Don’t accept vague promises, if you make an agreement with an employer where there is no formal ESOP in place, you have no guarantees and are essentially accepting an IOU. You should expect a formal contract, with solid lines of communication that can be relied upon to explain any necessary details.

If you have performed a thorough examination of a stock opportunity, make your decision accordingly, don’t accept secrecy, cynicism or false promises, good luck!

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