A stock option gives the holder a right, not an obligation, to buy a specified number of company shares at an agreed price after applicable vesting conditions. It is not the same as receiving cash or freely tradable shares. A valuable-sounding grant can still cost money to exercise, be hard to sell, or become worthless. This explanation is general information, not individualized investment, tax, employment, or legal advice.
The life of an option
Grant
The written award identifies the number of options, exercise or strike price, vesting schedule, expiration, and applicable plan documents. Ask for the fully diluted share count to understand what percentage the grant represents today.
Vest
Vesting determines when the right to exercise becomes available. A cliff, continued-service condition, or other rule may change what is available if employment ends.
Exercise
Exercising generally means paying the strike price and receiving shares, subject to the plan and company rules. The purchase may have tax consequences even without cash from a sale.
Hold or sell
Private-company shares may be illiquid and subject to transfer restrictions. An acquisition, public listing, or approved secondary transaction is possible but never guaranteed.
A small illustrative example
Suppose an employee has an option for 1,000 shares at an exercise price of $2 per share, and the award has fully vested. Exercising all 1,000 would require $2,000, before taxes or other costs. If a later sale were possible at $5 per share, the difference between sale proceeds and exercise cost would not automatically equal after-tax profit. Taxes, fees, dilution, preferences, and the timing of the transaction matter.
The SEC explains the basic right to exercise at a strike price after a vesting period. It does not imply that every startup follows a four-year schedule or that a 409A value predicts a future sale price. Read the actual plan and award agreement.
Questions to ask before deciding
In the United States, the IRS distinguishes statutory from nonstatutory stock options, and timing of income recognition can differ. Incentive stock options can raise alternative minimum tax questions. Those details depend on the grant and the holder's situation; speak with a qualified tax adviser before exercising or selling. Do not rely on an old article's simplified tax formula.
- What type of option is it, and which country's laws apply?
- What is the exercise price, expiration date, and post-termination exercise window?
- What percentage of the fully diluted company does the grant represent, and how may it change?
- Can shares be sold, and are there transfer or company-approval restrictions?
- What happens to vested and unvested options in an acquisition, financing, or departure?