How do stock options work in a private company
So what happens if you decide to take that leap of faith and exercise your options? It may not be the most glamorous part of equity, but taxes are important to keep in mind when you think about exercising your options.
Hopefully this brief introduction proved useful, but remember — it just scratches the surface of the topic of equity and how to make the most of it. If you want to learn more, consider doing some additional research online, talking to your HR and benefits team, or even setting up a meeting with a financial advisor. Are you an employer? Check out our Talent Solutions Blog. We're always looking for experts, executives and trends to feature on the Glassdoor blog.
Equity, Stocks, and Vesting There are two common types of equity grants made to employees: To Exercise, or Not to Exercise? Sales Capitol Office Solutions. Tags company equity Company Stock equity stock stock market stock options. Of course, the shares of stock for the pool and for stock option grants should be for common stock, as there are tax rules that make it very difficult to grant stock options for preferred shares or stock that has distribution preferences.
Prior to the first financing, it is common to have consultants, advisors, board members and non-officer employees receive option grants of. Sometimes, the founding team identifies an executive-level hire for a permanent, full-time position. In those cases, a much larger grant could be considered; perhaps 2 to 5 percent for a seasoned VP of Sales or CTO if one is needed in the early days , to as much as 10 percent for a seasoned industry-experienced CEO.
For grants to employees, startups often move towards a relatively rigorous process in which employees in specific job titles receive a fixed not a negotiated amount of stock. Such a hiring matrix helps the management team use the allocated stock pool more effectively and creates consistency among employees always a virtue. Further, after the company is funded, investors will expect the company to have such a matrix, and the board will expect management to keep all grants within the amounts specified in the matrix and, if amounts fall outside the matrix, the board will expect management to justify the exception.
Such a matrix is usually based on industry surveys conducted by companies such as Radford, Advanced HR, J. Thelander Consulting and the Ravix Group.
It is also not uncommon for angel or venture capital investors to provide guidance and help create company guidelines, which may be strongly influenced by local market practices. All stock option grants should have some vesting period because, with rare exception, the contributions the recipient will make will be in the future. For more information about founder vesting, please see our article here. Vesting is usually time based, typically monthly, but can also be based upon specific activities.
These activities could include attending important meetings such as advisory board meetings, performing specific activities or delivering certain work product. Note that there can be accounting consequences associated with such performance-based vesting; however, those consequences are likely not meaningful, as long as the relevant activities are performed prior to a first financing.
Even with early employees, startups should consider adopting the most common vesting formula: Of course, providing for some special vesting for an employee joining early might be justifiable, but in general the earlier that standard vesting is adopted, the better.
The reason for a one-year cliff is simply that a decision has been made to not award shares to employees who leave or are terminated before they have served for a year.
Setting the purchase price the "exercise price" or "strike price" of a stock option also is a very important consideration.
Incentive stock options ISOs must not have a purchase price that is less than fair market value FMV of the common stock on the applicable date of grant.