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What are stock options and how do they work?

By
Nicole Sara Sivens
November 8, 2018
8 min read
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Did you just land a new job and get some sweet stock options? Congratulations! Not sure what to do with them (or even what they are)? We’ve got you covered.

When you’re given stock options from your employer, you are given the option to buy a specific number of shares of the company stock -- but usually only during a time and at the price that your employer specifies.

There are lots of reasons why a company will do this, and they’re all pretty good: they want to attract and keep good workers (like you) or they want you to feel like an owner or partner in the business. Everyone is competing for the “good” jobs and in today’s market, employee compensation often goes beyond the standard salary. Stock options are just another example of that.

Here’s how it usually works: When you’re hired, you’re given the option to buy stock in the company at a predefined price called the “strike price.” For public companies, the strike price is based on the company’s price per share. For startups that aren’t publicly traded, they’ll usually set the price based on what’s called a 409-A valuation.

A 409-A is basically an evaluation of a company’s worth done by an outside firm.

You then hold on to those stocks until you are able to sell. This is called the vesting period and it is usually 3 to 5 years long, often with what’s called a “cliff” at the 1-year mark, meaning nothing vests until you hit the 1-year mark.

Companies find that this is a great way to incentivize employees to stick around. For you, the employee, the hope is that the company will do well and the value of the stock will increase. Then, after your vesting period is over, you can exercise your options, effectively buying shares at the predefined strike price and selling them at the current price for a profit, assuming the company’s value has gone up.

It’s generally considered a risky move to accept pure stock only compensation, but as a bonus, it can be a pretty sweet deal.

If you were given stock options as part of your compensation package, good for you! Sit tight, hold on to them until the vesting period ends, and then make a decision based on your financial situation and your long-term goals.

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