The benefit of options in a startup is common in high-tech companies. In the early stages of the company, it is customary to give employees options that if the company is successful and sells may be worth a lot of money. In more advanced stages, the practice of dividing options still exists and becomes much more structured and defined – receiving options upon entering the position.
We will present stock options to you and explain their meanings.In addition, we will discuss realizing your stock options.
What is Employee Stock Options?
Granting stock options to employees is an economic benefit, and is part of the company’s compensation scheme for its employees. You got the right to buy shares in the company at a pre-determined exercise price. If you came to work for the company at an early stage of its establishment. Consequently, the price of the options you will receive will be very low. However, you need to take into account that when investors come to invest in the company. As a result, the value of the options you receive will decrease significantly.
Stock Options vocabularies
The options have a vesting date and an expiration date. You cannot exercise your options before the vesting date or after the expiration date.
In order to understand better your employee stock options, you should know the following terminology:
- Exercise date – the date you do exercise your options
- Expiration date – the date you must exercise your options or they will expire
- Issue date – the date the option you got
- Vesting date – the date you are can exercise your options
- Market price – the current price of the company stock options
- Exercise price/strike price – the price at which your employee stock option can be purchased.
The longer the options are given, the greater the chance that their exercise will be worthwhile for the employee. As the chance increases that over time the share price will rise above the price of the option exercise. If the stock price stands at $25, and the exercise price of the option is $ 4, the employee can exercise the option. As a result, he receives a share and sells it at a profit of $ 21.
Companies tend to provide options that mature gradually, over four years in most cases. If an employee decides to leave the company, the right to exercise options is removed. Before leaving, however, he can decide whether to turn them into shares.
Why employee stock options is worthwhile for a company?
Companies that offer options to employees save some of the fixed expenses fixed in cash. They can convert them into the option to dilute the share of shareholders in the future. This dilution is unavoidable, as the company can issue a new share to the employee. Therefore receives a lower amount than a value in return.
Young high-tech companies tend to give their employees stock options. In order to save on wage expenses and encourage them to work hard. While employees can exercise the stock option, it will be difficult for them to sell them before an offering. The exercise price of the option is coming from the share price in the capital raising rounds of the private company. Thus, the first employees get options with a very low exercise price, which increases as the company progresses.
Creating a common interest
– The advantage of giving stock options is to link the interests of the employees. Besides to those of the shareholders, which may be conflicting. A too high a salary for the employees may harm the company’s profitability. However, an overly generous distribution of options will ultimately come at the expense of the shareholder public. So options are distributed in the appropriate proportions.
Is employee stock options worth it to employees?
Public companies usually provide information about the stock options. In other words, the stock options distributed can be found in the annual reports and in the prospectus before the issue. In this way, it is possible to examine the number of options that have matured. Following the number of options that have not matured and the average exercise prices. Shareholders can use this information to know the level of their dilution.
Your can also read more about EquityBee- Stock Options Platform, offering employees to fund their companies options.
For example, you receive one thousand stock options to buy shares at a certain price. Next, the company distributed 10,000 shares, you have 10% of the ownership in the company. But once investors come in they will share more shares. For example, the number of shares distributed increases to 100,000. Your share in the company will decrease to only 1%. Dilution protection does not exist – even for those who founded the company, because no investor will agree to give up the return on their investment.
When employees join at later stages, they get options to purchase the stock at its fair value at the time, a price determined by what they have invested in the company. Sometimes a company’s value may go down and then the options will be worthless. If, for example, an employee gets an option to purchase the shares for $ 4 but the value of the stock in the market drops to $ 2, it is not profitable for the employee to purchase the shares at the end of the transaction.
What is vesting?
In most plans, the right to exercise the option is after one year of the transaction. In order words, this is the vesting period (Vesting). Usually, assuming that no event like an exit has occurred. For example, the employee has no interest in purchasing the shares during the employment period. The right is retained for him as long as he is working. In most contracts, the right to purchase the shares is retained for three months after the end of the transaction.
In order for the options to constitute a very significant benefit, several conditions must be met:
- First is that the employee will enter at the beginning of the company’s journey;
- Second – that the company will succeed and prosper
- Third – that the dilution will be relatively low, meaning that even though investors came in, the amount of money that came in was not very large. These three conditions are extremely rare.
Of course, there have been cases of employees who received a great deal of money while a company was making an exit, but this is a matter of luck. If a certain employee is very important to the company and receives a certain rate at the beginning, and investors came, the company can give him more options in order to retain him, and he will be able to reach a considerable percentage and earn.
Important to remember, most startups do not make astronomical exits. Even if reading about exits in very high amounts one should check how much money has been invested along the way. For example, if a company exits for $ 400 million, but $ 500 million is invested along the way – the employee who had options in the company will probably not gain anything from this exit.
Also, when the company is acquired by an international company, usually the buying company does not want to have any more shareholders, and it will prefer to purchase the options from the employees of the startup company and grant them options in its company. That is, the new company acquires the options from the employees of the startup company and gives them options in its company.
What should you check in a contract to purchase company options?
Usually the options contract does not leave much room for negotiation, as the plan is uniform for all employees and is not personal. The goal is first of all that the granting of options will not limit the company – for example, that an employee will not be able to prevent the acquisition of the company.
It is usually possible to discuss the private economic matter, i.e. to see if the employee can purchase options at the par value of the share or whether he must get the option at the price of the last investment. If the employee was able to get the option at the face value when there is already value per share, this is a tax benefit and the employee needs to check what this means in terms of taxation.
For example, if the par value of the stock is $ 0.6 and the company does not yet have a market value, the employee will be able to purchase the stock at that value. On the other hand, if they have already invested and someone bought the company’s shares, usually the employee will not be able to purchase them for less than the purchase price, if he can purchase at a lower price – there is actually a benefit that the employee may be taxed on. That is, there may be a situation where the employee will be liable to tax on a benefit ‘on paper’.