Stock Options: 11 Questions
Stock Options: The Guide to Understanding and Evaluating Your Offer
Stock options can be an exciting and valuable part of your compensation package, offering you the chance to share in your company’s success.
But to truly understand their value and ensure you’re getting the best deal, it’s essential to dive into the details.
As an entrepreneur, I’ve always been excited about the equity play in businesses.
However, I’ve learned over the years that equity and stock options can be murky concepts for many employees, especially when I was trying to motivate teams.
This is particularly true for younger generations who tend to focus on the cash part of their compensation while underestimating the potential of stock options.
Note that not everyone gets stock options.
If you’re offered them, it often means the founders or leadership team values your talent and sees you as someone who can contribute to the company’s long-term success.
In a way, stock options are a badge of honor, a signal that your contributions matter.
However, like any badge, you’ll want to ensure it will be worth something—and understand how much it could be worth in the future, depending on the terms of your agreement.
Here’s how I see it: cash is king, but equity—ownership—is the king’s (or queen's) castle or land. And what is a king or queen without a castle or land to reign over?
Stock options represent your opportunity to own a piece of something greater, and understanding them is key to building long-term wealth.
This guide will help you understand the 11 critical questions you need to ask or clarify when reviewing a stock option offer.
By the end, you’ll be ready to evaluate stock options like a pro and see how they fit into your financial goals.
What We’ll Cover
Here are the 11 questions this guide will help you answer:
What kind of stock options am I getting?
How is the strike price determined?
What’s the vesting schedule?
How long do I have to exercise my options?
What is the company’s current valuation and growth potential?
Can I do a cashless exercise?
What happens if the stock price drops?
What happens if the company is sold?
How does this fit into my total compensation?
What are the tax implications?
Are employers required to notify me before expiration?
Let’s dive in!
1. What Kind of Stock Options Am I Getting?
Not all stock options are created equal, and the type you’re offered will affect how they work and how they’re taxed.
Incentive Stock Options (ISOs): These may offer tax advantages but are usually limited to employees.
Non-Qualified Stock Options (NSOs): These are more common and can be offered to employees, contractors, or advisors.
Where to Check: Your contract should clearly state the type of options you’re being offered.
When to Ask: If it’s unclear, ask your employer what type of options you’re receiving and how they are taxed in your country.
2. How Is the Strike Price Determined?
The strike price (or exercise price) is the amount you’ll pay per share when you exercise your options. This price is critical because it determines your potential profit.
Accounting Valuation: The strike price is often tied to an independent valuation (e.g., 409A valuation), which reflects the company’s financials and is usually lower than market value.
Market Valuation: This reflects how investors value the company, showing the growth potential of your options.
Where to Check: Your contract should specify the strike price and how it was calculated.
When to Ask: If the strike price seems unusually high or isn’t detailed, ask how the valuation was determined.
3. What’s the Vesting Schedule?
Vesting determines when you gain the right to exercise your stock options. Companies use vesting schedules to reward loyalty and encourage long-term commitment.
A common schedule is four years with a one-year cliff:
You earn nothing during the first year (the cliff).
At the end of the first year, 25% of your options vest.
The remaining 75% vests gradually over the next three years.
Key Considerations
Leaving Before Fully Vesting: If you leave the company before the cliff, you forfeit all your options. If you leave after the cliff but before the schedule is complete, you’ll only keep a prorated portion of your options.
Accelerated Vesting: Some contracts include accelerated vesting in cases like company sales. For example:
Single-Trigger Acceleration: All unvested options vest when the company is sold.
Double-Trigger Acceleration: Unvested options vest only if the company is sold and your role is terminated.
Where to Check: Your contract should outline the vesting schedule and any acceleration clauses.
When to Ask: If acceleration isn’t addressed, ask whether your vesting will accelerate or continue under the acquiring company in the event of a sale.
4. How Long Do I Have to Exercise My Options?
Stock options expire, so knowing how long you have to act is crucial. Most companies allow you to exercise vested options for a set period (e.g., 90 days) after leaving the company.
Where to Check: The expiration timeline should be detailed in the contract.
When to Ask: If it’s unclear, ask how long you have to exercise your options after leaving the company.
5. What Is the Company’s Current Valuation and Growth Potential?
The value of your stock options depends on the company’s performance. Understanding its current valuation and growth trajectory is key.
Current Valuation: This reflects the company’s worth today, often tied to recent funding rounds or financial reports.
Growth Potential: The company’s ability to meet its goals and scale will determine your options’ future value.
Key Details to Uncover
Trajectory Promised to Investors: What milestones or metrics (e.g., revenue, user growth) has the company committed to achieving?
Market Risks: What external factors, such as competition or regulatory changes, could impact the company’s ability to grow?
Your Role: How does your position contribute to meeting these goals? Are there specific timelines or deliverables where your work will have the most impact?
Where to Check: Contracts may not include valuation details, so research funding rounds or ask the recruiter for insights.
When to Ask: If you’re unclear about the company’s growth plan, ask how the business plans to meet its goals and how your role aligns with those plans.
6. Can I Do a Cashless Exercise?
A cashless exercise lets you buy and sell shares in one transaction, using the proceeds to cover the purchase cost. This can make exercising your options more accessible if you don’t have cash upfront.
Sell-to-Cover Example with NVIDIA
Imagine you were granted 1,000 stock options at a strike price of $0.10 when NVIDIA was founded. Today, NVIDIA’s stock is worth $500 per share:
To exercise all 1,000 options, you’d pay $100 (1,000 × $0.10).
Using the sell-to-cover method, you could sell 1 share for $500 to cover the $100 cost (leaving $400 for taxes/fees).
You’d keep the remaining 999 shares, which you could hold indefinitely to benefit from future growth.
This strategy ensures you can afford the exercise without using your own cash and still retain most of your shares.
Where to Check: This may not be in the contract—check with HR or the company’s broker.
When to Ask: If cashless exercise is important, confirm whether it’s available and whether there are restrictions.
7. What Happens If the Stock Price Drops?
If the stock price falls below your strike price, your options may become worthless (“underwater”). This doesn’t cost you anything but means you won’t profit unless the stock price rebounds.
Where to Check: Your contract likely won’t cover this.
When to Ask: If concerned, ask whether the company has policies, like repricing, to adjust for declining stock value.
8. What Happens If the Company Is Sold?
Your options’ value may depend on the company’s exit plan, such as a sale or IPO.
Where to Check: Look for clauses on acquisitions, mergers, or IPOs.
When to Ask: If the contract doesn’t address what happens to your options in a sale, ask whether your vesting will accelerate or continue under the new ownership.
9. How Does This Fit Into My Total Compensation?
While stock options are exciting, they’re just one part of your compensation. Make sure they complement a competitive salary and benefits package.
Where to Check: Compare your offer’s details with market standards.
When to Ask: If the total package seems unbalanced, discuss how the stock options fit into your overall compensation.
10. What Are the Tax Implications?
Taxes can significantly impact your profits, so understanding when and how you’ll owe taxes is critical.
You may owe taxes when you exercise your options, sell your shares, or both.
For ISOs, taxes may be deferred until you sell, while NSOs are typically taxed at the time of exercise.
Where to Check: Tax obligations may not be detailed in the contract—consult a tax advisor.
When to Ask: If you’re unsure, ask how your options will be taxed at exercise and sale, and whether there are strategies to reduce the tax burden.
11. Are Employers Required to Notify Me Before Expiration?
Employers are often not legally required to notify you before your stock options expire, though some companies send reminders as a courtesy.
In the U.S., companies must disclose expiration terms upfront but are not obligated to send reminders.
In the EU, UK, and France, transparency laws ensure clear communication when options are granted, but expiration notifications are rarely mandated.
Since tracking options is ultimately your responsibility, make sure to:
Log into equity platforms regularly.
Set personal reminders for expiration dates.
Tip 1: Ask your employer if they provide reminders or use an equity management platform for tracking.
Tip 2: If you've been offered stock in the past check in with your old employer to get clarity in what you've earned, lost etc. Don't let money or your hard work get lost!
Final Thoughts
Stock options can be a life-changing opportunity, but only if you understand their true value and conditions. By answering these 11 key questions, you’ll gain the clarity and confidence to evaluate your offer and make informed decisions.
Remember, cash is king, but equity is the king’s (or queen's) castle—and what’s a king or queen without land to reign on. Take the time to get the answers you need and position yourself for long-term success.
