A stock option grant is a contract giving the recipient the right, but not the obligation, to purchase a specified number of shares at a fixed strike price after satisfying a vesting schedule. Typically, options vest over a four-year period with a one-year cliff (meaning the first 25% vests on the first anniversary, with the remaining 75% vesting monthly over the next 36 months).
Startups often offer options as a core component of compensation. However, approximately 72% of employees never exercise their options. This is driven by high upfront exercise costs, the risk of company failure, and the lack of a market to sell the underlying shares.
To evaluate the potential value of stock options, you must analyze both the company’s valuation and the total outstanding share count. A grant of 1,000 options is meaningless without context; in a startup with 100,000 shares, it represents a 1% initial stake, but in a company with 10,000,000 shares, it is 0.01%. Furthermore, this percentage is subject to dilution if the company issues additional shares to raise capital or expand its employee option pool.
For private companies, the fair market value (FMV) of the stock is determined by an independent appraisal under IRC §409A, whereas for public companies, the FMV is the market price on a national exchange. Additionally, employees receive common stock, while venture capital investors receive preferred stock. Preferred stockholders have liquidation preferences (the right to be paid first in a sale or liquidation) and may receive dividends before common shareholders.