Deal Terms
Last updated
Quick Answer
The price per share at which an option holder can purchase shares — same as strike price, set at fair market value on the grant date.
Exercise price (or strike price) is the predetermined price at which a stock option holder can purchase company shares. Under IRS regulations, options must be granted at or above fair market value (FMV) at the time of grant — hence the need for 409A valuations to establish FMV. If you receive 10,000 options with an exercise price of $1.00/share, you can purchase those shares for $10,000 total regardless of what the shares are worth when you exercise. Options are 'in the money' when current FMV exceeds exercise price (profitable to exercise), and 'underwater' when FMV is below exercise price (no rational economic reason to exercise). Exercise prices are set once at grant — they don't change unless the company reprices options (a controversial practice).
In Practice
If an employee receives options when the company's 409A valuation shows $2.00 per share fair market value, their exercise price is set at $2.00. Two years later, after a Series B round prices shares at $8.00, the employee can still purchase shares at their original $2.00 exercise price. If they exercise 10,000 options, they pay $20,000 to acquire shares worth $80,000 - capturing $60,000 in paper value.
Why It Matters
Exercise price directly determines the economic value of stock options for employees and founders. A lower exercise price means greater upside potential when the company's value increases. Understanding exercise pricing helps founders design effective equity compensation packages and helps employees evaluate job offers. The spread between exercise price and current share value drives key decisions about when to exercise options and tax planning strategies.
VC Beast Take
Exercise price is where 409A valuations become critical - aggressive low valuations benefit employees but invite IRS scrutiny. Many founders don't realize that exercise prices generally only go up over time, making early employee grants incredibly valuable. The rise in extended exercise windows shows companies recognize that traditional 90-day post-departure exercise periods were forcing unnecessary early exercises.
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Exercise price (or strike price) is the predetermined price at which a stock option holder can purchase company shares. Under IRS regulations, options must be granted at or above fair market value (FMV) at the time of grant — hence the need for 409A valuations to establish FMV.
Understanding Exercise Price is critical for founders navigating the fundraising process. It directly impacts deal terms, valuation, and the relationship between founders and investors.
Exercise Price falls under the deal-terms category in venture capital. This area covers concepts related to the financial and legal terms that define investment agreements.
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