Stock options are a form of compensation that gives employees, founders, or investors the right to purchase a company’s shares at a predetermined price, known as the exercise or strike price, within a specified time frame. These options become valuable if the company’s stock price increases, allowing the holder to buy shares at a lower price and potentially sell them at a profit.
How do stock options work?
Stock options grant the holder the right, but not the obligation, to buy shares at a set price (strike price). Typically, the options are subject to a vesting schedule, meaning they become exercisable over time. For example, an employee might receive 1,000 stock options that vest over four years. Once vested, the employee can purchase shares at the strike price, regardless of the current market value.
What is a vesting schedule?
A vesting schedule determines when an individual gains the right to exercise their stock options. For example, a common schedule is a four-year vesting period with a one-year cliff, meaning the employee earns the first portion of options after one year and the remainder monthly over the next three years. Vesting ensures that employees stay with the company to realize the full value of their options.
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