Many employers include stock options as a part of the compensation package when making a job offer. 6 things to know about them are:
- a stock option is the opportunity to buy company stock, not a gift,
- it may not vest immediately,
- the purchase price should be at a discount,
- whether there are future opportunities to exercise your stock options,
- they may get diluted by subsequent stock options, and
- termination policies.
These issues can drastically undermine the value of the stock option.
1. Stock options are not a gift of company stock
Contrary to popular belief, a stock option in a job offer is not an upfront gift of company equity. Instead, it is an opportunity to buy company stock in the future, often at a discounted price. The precise details of that opportunity can make a big difference in its valuation. Some of the most important details are:
- when the option to buy stock will vest,
- what the discount will be,
- how much stock you can buy,
- the current value of the stock,
- how much company stock is available,
- your percentage of that total stock available,
- whether the company can issue more stock and dilute what you have, and
- what happens to your stock when you leave the company or get terminated.
Small details on any of these issues can completely undermine the value of what you stand to receive. Given that stock options may be a sizeable chunk of your compensation package, it is crucial to understand the value of the offer. Consulting with an employment law attorney so you can make an informed decision regarding the offer letter is extremely important.
2. Your option to purchase may not vest immediately
Many stock options do not let you purchase stock immediately after you accept the job offer. Instead, the opportunity to purchase company stock only begins, or vests, later on. Only when your stock option vests can you begin to purchase company equity.
A common options vesting schedule involves a four-year time frame with a one-year cliff, or delay. During your first year with the company, you will not be able to exercise any of your stock option. At the beginning of the second year, you can purchase one-quarter of the shares available to you. You can exercise your right to the next quarter at the beginning of the third year, and the next quarter at the beginning of the fourth year, and the remainder at the beginning of the fifth.
Note that each vesting period opens up another opportunity to exercise your stock options. You are not obligated to buy stock at that time. Whether you lose the right by not exercising it is an important issue that should be covered in the stock option agreement.
Some companies, however, will allow for an early exercise of your stock options in some circumstances.
If you leave the company before your stock option vests, though, you lose the opportunity to buy company equity.
3. The purchase price is generally at a discount
Stock options generally let you purchase company equity at a discounted price. Also known as the “strike price,” “exercise price,” or the “grant price,” this is often a slight reduction of the price at the time of your hire.
The stock option agreement should be clear about what this price is, and whether it will change if you exercise future options.
4. You may get more opportunities to buy company stock
The stock options made in an initial job offer may be a one-time company perk or an ongoing opportunity. If the stock option is a big draw in your job offer, you may want to find out which it is. In some cases, the options in the job offer are the only ones you will get. In many other cases, you may get additional employee stock options:
- as an annual bonus,
- when the company hits earnings goals,
- at regular intervals for continuing to be with the company, or
- when you get promoted.
These opportunities to buy more equity in the company can end up being very lucrative and enticing.
5. Options offered to other workers can dilute your shares
It is important to remember that the number of shares that you have is not as important as your percentage ownership of the company. When considering a job offer with stock options as a form of equity compensation, an important thing to know is whether subsequent stock options will be made to others. If they are, it can dilute your ownership share.
A key piece of information to learn is the number of authorized shares there are in the company. This is the maximum number of shares the company can issue. It can give you a better idea of the value of your shares.
You will also want to know what happens to your shares if the company increases the number of authorized shares. If your shares are not increased alongside the authorized pool of shares, your equity will suffer from the dilution.
6. Company policies regarding your stock when you leave
You will also want to know what the company’s policies are for when you leave or are terminated. If there is a buyout policy for your vested shares, the terms of that policy can be extremely important.
What are stock options?
A stock option is the opportunity to purchase company stock, typically at a discounted price. Because the stock’s value can increase as the company grows, it can be a lucrative form of job compensation. However, if the value decreases below the purchase price, it can actually hurt your finances.
Importantly, not all stock options are the same. Your employer may offer different types of equity, such as:
- common stock,
- restricted stock units (RSUs),
- non-qualified stock options (NSOs), and
- incentive stock options (ISOs).
Which type is included in your new job offer can make a huge difference in its fair market value.
Are they more common in job offers by startups?
Startups tend to use stock options when enticing new workers. They often do this because:
- the stock’s share price generally cannot fall very much during the company’s early days,
- the potential for extremely high returns on the stock exists, and
- new companies generally do not have very many other assets to offer new startup employees.
However, they are also widely used in job offers made by the following types of established private companies:
- healthcare, and
- tech companies.
Why do employers offer them?
Employers use stock options to lure talented workers to their company for several reasons, including to:
- align the financial interests of the company and the worker,
- improve worker dedication and loyalty,
- incentivize longer working hours and productivity,
- reward long-time workers with a lucrative buy out,
- provide a retirement benefit for employees, and/or
- attract workers while offering a salary that may be below industry standard.
However, there are many circumstances where they are not in your own interests. If stock options are a part of your job offer, you should strongly consider talking with an employment lawyer. You may want to negotiate the offer to better suit your needs.
Can they be negotiated?
Yes, stock options or company equity stakes made in a job offer can be negotiated. For interested employees who do not necessarily intend to make use of their stock options, negotiating them is likely in your best interests.
There are many reasons why you may not want stock options in the company making a job offer. For example:
- you are risk-averse and do not like the possibility that you could end up losing money on them,
- you already have a healthy retirement portfolio,
- you do not think that the company’s stock price is going to improve much over time,
- you do not intend to be with the company for as long as it takes for your stock options to vest, or
- the job offer’s description of your stock options are vague and your questions are going unanswered.
In these cases, you may want to negotiate the offer. You may be able to get other perks that you actually want in exchange for turning the stock option down, like a higher base salary.