Deal Terms
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Quick Answer
The right to purchase company stock at a fixed price (strike price) in the future — the primary equity compensation tool for startup employees.
A stock option gives the holder the right (but not obligation) to purchase a specified number of company shares at a predetermined strike price within a defined time period. Options are the primary equity compensation tool for startup employees because they require no upfront purchase — employees wait until exercise is advantageous (when shares are worth more than the strike price). Types: Incentive Stock Options (ISOs) receive preferential tax treatment (capital gains at exercise, potential AMT trigger) and can only be issued to employees; Non-Qualified Stock Options (NSOs/NQSOs) are taxed as ordinary income at exercise and can be issued to advisors and consultants. Options expire (typically 10 years from grant, or 90 days after leaving the company — though many startups now offer extended exercise windows). The option expiration after leaving is a critical, often overlooked employment term.
In Practice
TechCorp grants software engineer Sarah 10,000 stock options with a $1.00 strike price when the company's 409A valuation sets the fair market value at $1.00 per share. The options vest over four years with a one-year cliff. Two years later, TechCorp raises a Series B at $5.00 per share. Sarah can now exercise 5,000 vested options by paying $5,000 ($1.00 × 5,000) to acquire shares worth $25,000 ($5.00 × 5,000), creating $20,000 in paper value. However, she must pay taxes on the $20,000 spread and cannot sell the shares until a liquidity event like an IPO or acquisition occurs.
Why It Matters
Stock options are the primary wealth creation mechanism for startup employees, often representing 80-90% of total compensation value at successful exits. Misunderstanding vesting schedules, tax implications, or exercise timing can cost employees hundreds of thousands of dollars. For founders, poorly structured option programs create retention issues and tax headaches. The 90-day post-termination exercise window frequently forces departing employees to forfeit valuable options they cannot afford to exercise.
VC Beast Take
Most employees treat options like lottery tickets instead of understanding the mechanics. The dirty secret? Options below the liquidation preference stack often end up worthless even in 'successful' exits. Smart employees negotiate for RSUs or ask detailed questions about liquidation preferences before getting excited about their option grants. The explosion in secondary markets is finally giving option holders some liquidity before traditional exits.
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A stock option gives the holder the right (but not obligation) to purchase a specified number of company shares at a predetermined strike price within a defined time period.
Understanding Stock Option is critical for founders navigating the fundraising process. It directly impacts deal terms, valuation, and the relationship between founders and investors.
Stock Option 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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