I worked for a startup and as an employee, was “granted” 34,000 “Options” and “vested” in 8,000 “Options (ISO)”. The company has not gone public yet but likely will in the next 3-5 years. I just left the company and the exit paperwork says “Upon termination, you have three months to exercise your Options before they expire.” I have no idea what this means. What happens if I exercise them? What happens if I don’t? What does it even mean to exercise them? Please help.
In: 72
An option is a contract. You make an agreement with someone for…wait for…the “option” to buy or sell a stock at a given price. But generally you are also not *required* to. To exercise a stock option simply means you’re going through with the agreement. An alternative is just to let the option expire which means you’re not going through with it by the expiration date.
Assuming they are “call” options (which they would be, since you got them from working for the company), to “exercise” them means to purchase shares of the company’s stock at the “strike price”.
If the strike price is lower than what you think a share of the company’s stock is worth, then you might want to exercise them. You could immediately sell the shares if you can find a buyer. Or if you think the company is likely to succeed and go public, you could hold the stock until then.
If you don’t have access to funds that would be needed to purchase the company’s stock at the strike price, you might be able to sell the options to someone who wants to invest in the company. But you would need to do so before the 3 month period is over, because the options can’t be used after that point.
“Vested” usually means that you’re entitled to them at a specific point in time. As for the options that weren’t vested immediately upon your hiring, they may or may not have become vested after you were hired. This typically depends on how long you worked for the company.
The specifics of your option grant matter a lot. But based on what you said, you have 8,000 stock options in your company (the rest of the granted ones are likely void now that you’re leaving). There will be a strike price associated with those options. Let’s say the strike price is $1. You have the option to buy up to 8,000 shares of your company for $1 per share. If it were a public company, you would only do this if the current stock price was greater than $1. So if the stock was trading at $2, you would exercise your options. That would mean you would effectively buy the stock for $8,000 and sell it for $16,000, pocketing $8,000.
Since it’s a private company, it’s probably harder to sell the shares, or even determine their fair market value. It’s hard to know without seeing the grant document, but you can probably pay the grant price for the $8,000 shares. And you may not be able to sell them unless/until the company goes public. It’s not as clear cut a decision as it would be for a public company, but if you think the company will go public at a higher valuation than your options were granted, it may be a good deal. If you’re at all unsure about that, I’d pass and let them expire.
In this case, it simply means to “sell” your shares.
Stock brokers love to make up new words to make their business sound more complicated than it really is. 😉
There’s a number of options and a strike price. Say you have 10,000 options with a strike price of $10. You have to pay $10 x 10,000 = $100,000 to buy them.
But ideally the company has IPO’d and each share is now with $30.
So you pay $100,000 to exercise the options but they’re worth 3x that on the open market. So you can turn around and sell them for a $200,000 gain pre-tax.
There are other possible paths if the company sells instead of IPOs or if you can sell the shares back.
In your case you can buy them and wait to see if the market price at ipo is higher. If it’s not then you lost money.
Keeping it ELI5: An option is, as the English word suggests, a choice. You have the option to do something or not do it.
When you “exercise an option” you’re choosing to do that thing. So, if I give you an option to buy a cookie for $1, and you exercise that option, then you give me $1 and I’ll give you a cookie. If you don’t exercise the option, then you keep your $1 and I keep the cookie. No pressure… it’s totally up to you.
Going a bit deeper with start-up stock options, as I have been through this a few times…
When you join a start-up you’re typically given (granted) an option to buy a certain number of shares at a specific price. I’ll use made-up numbers so as to not confuse you with any specifics that match your case. Let’s say you’re given 10,000 options at a price of $1.
You haven’t been given stock… you’ve been give the opportunity, the choice, to buy stock (up to 10,000 shares) at the set price ($1). You’re under no obligation to buy, and if you do exercise the option (i.e. choose to buy) then you’re under no obligation to buy them all in one go.
A start-up may run for many years before going public, getting bought, or shutting down. The thing about start-up stock is that all start-ups are a risk. If you exercise your 10,000 options at $1, and spend the $10,000 then the _hope_ is that one day the company will be successful and you’ll be able to sell those shares for a profit. But, and this has happened to me, sometimes the company doesn’t make it and you’re out the money. The company dies, and the stocks are worthless. That’s the risk, and you have to be comfortable with that.
The Fair Market Value (FMV) of a share is the current value of one share as filed in company paperwork. When you’re granted option, you’re granted them at the FMV price on the day… so $1 in this case.
The value of a share will change whenever there’s a significant financial event, such as getting more investment (i.e. a funding round). If the company is getting lots of customers and lots of orders, its value may also be independently reevaluated.
Why this matters:
If you exercise your options when they’re granted, then you’re buying them for $1 and the FMV of the stock is $1. So you’re not getting a “deal”. You’re paying the fair price. You’re buying a $1 cookie for $1.
If you wait, say, 2 years to exercise and in that 2 years the company has been through a funding round or two and now the FMV for a share is $3, then you’re still only paying $1 per share (per your option grant) but now you’re buying a $3 cookie for $1… and that’s a capital gain of $2 per share. Even though you can’t SELL your stocks. Even though you haven’t made any REAL profit, the tax man sees you buying a $3 thing for $1. You’re getting a deal, and the tax man wants his cut.
So in your case, if you’re leaving the company you need to look at the FMV of the stock and one of two things:
Either, the FMV is the same as your grant. That’s easy. If you choose to exercise your option then buy the $1 cookies for $1 and hold them. Cross your fingers and hope the company does well.
But, if the FMV is now higher than your grant, then if you exercise you’ll need to declare the “gain” on your tax forms, and PAY for the gains (the difference between the FMV and the option price). That may be significant or it may be trivially small.
I’ve seen start-up stock go from $0.01/share to $3/share and THEN the company just die. And, yes, friends who made the hard choice to buy their shares when they left the company (before it died, but when the FMV was high) were TOTALLY SCREWED.
If you choose to not exercise your options, then they just expire. You lose the option to buy them later. No big deal. Don’t feel pressured if you don’t think the company is going to be successful.
By the way: ALL start-ups think they’ll go IPO in 3-5 years. The local cemetery is full of the graves of start-ups who were going IPO in 3-5 years.
I am not a tax advisor or lawyer. Everything above does not constitute financial advice, may be incorrect, and is for entertainment purposes only.
I’ve been in a few start-ups, and these sorts of things were always heavily discussed between staff… everyone talks about this stuff. It’s not a secret. Everyone is at a start-up for the stock. You shouldn’t feel awkward reaching out to your colleagues.
Man people have some advanced five years old.
Your compensation included options to buy shares in the company. Your employment contract should have specified the price to exercise those options. I.e. cough up the money to buy the shares. You can choose to do this for 0-8000 shares.
Should you? I it depends. Having worked through the dotcom boom and bust, I’ve been there and had lots of friends who had options.
So for example I had options that were vested in a company that was not public. I could buy them for $9 per share. The company got bought out at $34 per share. To get my $34 I had to give them $9. Repeat for all the options I had vested. They were cool enough to just have you agree to get $25 and not have to come up with a big wad of cash out get nothing.
Now one of my friends as part of their benefits got options for a public company. They were given options with each pay period. Basically they had to pay $3.95 for each share or forfeit the option. Market price was well above $3.95. The option contract may be encumbered by other terms. In this case, if you left the company the company had the right to buy them all back at current market value rather than let you sell them on the open market.
They can also be a boondoggle. Like I knew several people who worked for dotcom startups with no business plan that gave them options at the ludicrous valuations they gave themselves. So paying $75 a share for something that nobody wanted would be unwise. Even with a more promising startup, there’s always a risk they have overvalued themselves. If yet give you a share for $125, and then go public at $55, you got screwed if you exercised your options.
An option is a contract that gives you the OPTION to buy or sell stock at a future date at a pre-agreed upon price. Exercising an option means you are exercising (using, applying) your right to buy or sell that stock.
Oh, neat. I’m an attorney and my practice focuses on private companies (mostly startups). Option grants and exercises are well within my wheelhouse. This will not be ELI5, but hopefully ELI “reasonable adult” and I’ll answer further questions if you have any. I’m tired and my meds are wearing off, so please forgive me if this is not comprehensive.
**Obligatory: this is not legal advice, I am not your attorney, I cannot advise you as to the legal nuances of your option.**
I can, however, try to explain the basics as simple matters of fact. For a more thorough explanation of *your* option grant, you need to get your option grant paperwork (request this from your former employer) and an attorney who does this kind of work (not a Swiss-army-knife attorney who does everything). This is a very broad-strokes explanation. There is *a lot* I don’t go into here that you should consider (taxes, preference, participation, etc.). If you are seriously considering exercising your option, consult with an attorney.
**TL;DR:** you have the right to buy up to 8,000 shares of stock of your former employer at a price that was set around the time you were hired.
Your former employer (the “Company”) is (most likely) a corporation. It may be a “limited liability company” or “LLC,” but it doesn’t matter for this.
A “share” is a portion of the Company. Not in the sense that owning shares means you own the HR department, or desks, or computers. More in the sense of if the Company gets sold, you get a cut of the dough. With startups, this is sometimes not straightforward and you should consult with an attorney about the details.
An “option” is a right to *purchase* shares at a specific price. You and the Company made a deal: you work for them and they pay you cash, they promise that you can buy shares, they promise you can buy more shares the longer you work for them, and they promise that you can buy those shares at a specific price. That price will (likely) be the fair market value of the shares at the time you and the Company made your deal.
That price is called the “exercise price” or “strike price.” It is set in stone.
“Exercising” your option means demanding to buy shares at that price. Same as “exercising your rights” because that’s what it is: you have a legal right (but not an obligation) to purchase up to a number of shares at the exercise price.
Your option has “vesting.” Vesting simply means that the number of shares you can demand to buy grows over time. This is the “they promise that you can buy more shares the longer you work for them…” I mentioned before. At first, you could demand to buy zero shares. That number went up while you worked for the Company. Today, you can demand to buy up to 8,000 shares of the Company at the exercise price. Your option has “vested” over 8,000 shares.
Your option “expires” after a certain time. “Expires” simply means you cannot demand to buy shares. Same as a coupon: when it expires, it just don’t work no more.
Why did the Company offer you an option as part of your pay? A few reasons. The most important one right now is that giving options doesn’t cost the Company cash. The Company can give you a better offer without paying you more out of pocket. Employees like options because, if the company does well, the employee could buy shares at a hefty discount and sell them for a profit later (among other things). This, in turn, means that companies like options because it gives employees another reason to work hard and to stick around. The employee’s option becomes more valuable as the company does better and as the option vests.
The best case for you is that the Company has done very well and is worth a lot more today than it was when your exercise price was set, because that means you can buy up to 8,000 shares for much less than they would cost today.
Let’s pretend that your option has an exercise price of $0.10 per share. You could buy the entire lot for $800, and let’s pretend that you do. You have 8,000 shares. What are they worth today? Hopefully more. $0.20 each? $1? $3? Again, talk to an attorney. But if they are worth more, you can own shares worth far more than the $800 you paid for them.
Imagine being able to buy shares of Google at a price from 2004 (~$3 per share) today. Those shares, right now, are worth about $136. Would you take that deal? Hell yeah you’d take that deal. Damn good deal. I doubt the Company has had such a huge increase over the course of ~1 year (guessing based on your vesting schedule), but it still may be a nice return.
You may not even have to pay– a “[cashless exercise](https://www.investopedia.com/terms/c/cashlessexercise.asp)” may be available. Again, attorney.
ISO is just a type of option. “ISO” stands for “incentive stock option.” If you see “statutory stock option” or “qualified stock option,” those are the same thing. ISOs can only be offered to employees (not contractors) who are US taxpayers. ISOs get favorable tax treatment. The other type is called a “non-qualified stock option,” or “NSO” for short.
Sometimes people say you have “8,000” options, but that’s shorthand. You have *an* option to buy up to *8,000* shares.
Finally– some additional resources written by folks who have editors and who are not fighting to keep their eyes open:
1) https://www.investopedia.com/articles/stocks/12/introduction-incentive-stock-options.asp
2) https://carta.com/blog/what-are-incentive-stock-options/
Investopedia has a bunch of information about securities, investing, etc. Carta is a platform that companies use to manage their stock and other securities (like options!). Both of them have better quality writing than what I’ve put together. But I hope my post is helpful!
In general terms:
Imagine if I give you a piece of paper that says “I promise to gives you some shares on date xxxx/xx/xx, if you want them, at price X”. These are your options.
Now imagine some of those options had a date which has already passed. These are your vested options.
If you go to the person who gave you the piece of paper and say, “I want the shares you promised me”, that’s exercising your vested options.
When they give you the shares, you have to pay the price that was written on the paper. Hopefully, that price is a lot lower than what the shares are trading at on the open market. You can then sell the shares at the market price, let’s call that price Y.
This makes you money in the amount of:
> (Number of shares) x (Price Y – Price X)
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