What Are Stock Options?

Startups often use equity to help attract and keep talented workers, typically by either using stock options or restricted stock.

Stock options give employees the right to buy a specific number of shares of the company at a specified price (the "strike price") during a window of time. The strike price is the fair market value market price of the stock at the time the option is given. Ideally, the price of the stock then goes up over time and provides the worker with a profit when they sell the stock down the road.

For example, Company X grants a worker the option to buy 1,000 shares of its stock at $10.00 a share on August 1, 2012. Typically, under both a stock option plan or a restricted stock purchase agreement the equity vests on a four vesting schedule. Therefore, one-fourth of the total 1,000 shares (250 shares) would vest after the first year, another 250 shares after the second year, third year, and the final 250 shares on the fourth anniversary of the agreement.

Fast forward to August 1, 2013, and the stock is worth $20.00 a share. The worker could convert the options to stock by buying it at the strike price of $10.00 a share and then either selling the stock after a waiting period for a $10,000.00 profit, keep the stock in the hopes that it will continue to increase in value or sell some of the stock and keep some of the stock.

You may also want to read this blog post, which outlines the difference and similarities of stock options and restricted stock purchase agreements and some of the reasons why most startups select restricted stock when compensating their workers.