If you sell the shares as soon as you exercise them, the bargain element is treated as regular income. In a broad sense, stock options are a valuable way that you can compensate your employees for the hard work they do to help make the company successful. We’ve created this “employee stock options for dummies” guide to help you better understand stock options and how they work. Have a question? What is the strike price? Compare the Top 3 Financial Advisors For You, There are many factors that can affect when the best time to sell a stock option is. Each contract specifies the number of shares the recipient is entitled to and how long their vesting period is. Companies can offer two types of stock options—nonqualified stock options (NQSOS) and incentive stock options (ISOS). These options, which are contracts, give an employee the right to buy or exercise a set number of shares of the company stock at a pre-set price, also known as the grant price. Companies can also offer shares of their stock to contractors, consultants, and investors. With NQSOS, stockowners only pay taxes when they exercise their stock options. The discount … What Are Employee Stock Options (ESOs)? Have there been any changes in your company’s stock option plan in the past 12 to 18 months? There are four basic steps in creating an employee stock option plan: Your employees and other stockowners should also be made aware of the tax implications of exercising their stock options. We want you to be able to determine at a glance what you can offer your employees, consultants, investors, and contractors because you have the assurance of knowing that your data is accurate and current at all times. Let’s say your four years have elapsed, and you now have 20,000 stock options with an exercise price of $1. That said, if all indicators point to a climbing stock price and you can afford to hold your shares for at least a year, you may want to exercise your options now. What kind of stock options — incentive, nonqualified, or a combination of both? The contract will also state how many shares the employee can sell. It will also depend on the seniority and special skills of the employee. The first lesson in stock options for dummies is to understand your contract. So why not wait until the market price is where you would sell? An author, teacher & investing expert with nearly two decades experience as an investment portfolio manager and chief financial officer for a real estate holding company. 1  Your options will have a vesting date and an expiration date. There is a limit of $100,000 aggregately on the value of the ISOS grant that can be vested in any calendar year. Your potential new job includes stock options as part of your compensation package. Unfortunately, you will not receive all of your options right when you join a company; rather, the options vest gradually, over a period of time known as the vesting period. This is where that one-year cliff comes in: This means that you will need to stay with the company for at least one year to receive any of your options. Employees come on board at perhaps a lower-than-normal salary in exchange for the possibility of a big payday later on. The number of options that a company will grant its employees varies, depending on the company. When I’m promoted? When a stock option vests, it means that it is actually available for you to exercise – that is, to buy. That also gives your employees an extra incentive to remain in your employment. Creating a stock option program can seem complicated, especially if you don’t have a background in finance. There are also income tax considerations, with the promise of lower tax rates if you hold onto your shares for at least one year. This is the date that the stock options will begin to vest, which means this is the date that employees can sell stocks. Stock options…, Employee stock options are often dubbed ESOs and they can be a useful tool for startups…, ©EQUITYEFFECT 2019   •  TERMS OF USE  •   PRIVACY POLICY, How do stock options work? For example, let’s say you have an exercise price of $2 per share. Employee Stock Option Basics With an employee stock option plan, you are offered the right to buy a specific number of shares of company stock, at a specified price called the grant price (also called the exercise price or strike price), within a specified number of years. While you need top-quality talent to get your company up and running profitably, your bottom line may not allow you to pay top dollar for top talent. When stockowners sell their shares, they get taxed under the rules for capital gains and losses. Stock options are contracts that give employees the right to buy or exercise shares of company stock at the grant price, which is a pre-set price. Employee stock options (ESOs) are a type of equity compensation granted by companies to their employees and executives. Stock options are a form of compensation. A, Exercising and selling will impact your taxes. The third lesson for stock options for dummies is to learn the three ways stock owners can exercise their stock options. Best-in-class Fund-level Scenario Modeling, Tax Implications of Exercising Stock Options, How to Create an Employee Stock Option Plan. Can I please see a copy of the stock option agreement that I’ll be asked to sign? You can also hold it and hope that the stock price will go up more. NQSOS is the most common type of stock option. What percentage of the company’s total ownership do the shares on my stock option represent? Your employer might also require that you exercise your options within a period of time after leaving the company. What you can do to show appreciation for your employees is to look for non-salary ways to compensate them. Until you exercise, your options do not have any real value. In this case, let’s say the options have a four-year vesting period, with a one-year cliff. Once you exercise them, your money is sunk in those shares. That’s where employee stock options come into play. Second, once your company has its initial public offering (IPO), you’ll want to exercise your options only when the market price of the stock rises above your exercise price. Once your options vest, you have the ability to exercise them. Finally, it’s also important to mention that your options do have an expiration date. You should familiarize yourself with the terms in that contract. We believe that maintaining your cap tables should be easy and not time-consuming. It’s also common for stock option contracts to state the employee’s options to exercise their stock expire once they choose to leave the company. You may hear people refer to this price as the grant price, strike price or exercise price. When can I next anticipate receiving another stock option grant, and under what circumstances (An annual grant? And because the value of your options are linked to how well (or badly) a company is managed, you can benefit by knowing the signs that your stock values may be going up or sliding down. With ISOS, the shares qualify for special tax treatment and these shares aren’t subject to Social Security, Medicare, or withholding taxes. Companies can grant them to employees, contractors, consultants and investors. One other thing to consider is called the “cliff.” The “cliff” refers to the waiting period before any of the options vests, which would be a year if the contract states it has a one-year cliff. This offer doesn’t last forever, though. You do not pay taxes when you exercise ISOs, though the amount of the bargain element may trigger the alternative minimum tax (AMT).