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The Basics To Understanding Employee Stock Options

Many startup employees don’t know how stock options work. Here are the basics.

1. They vest usually over 4 years either monthly, quarterly, or annually. They’re not yours until they vest.

2. Once they vest you have a limited time window to exercise them. Usually 90 days after leaving the company. “Exercise” means you buy them.

3. Once you exercise them, if you sell them without holding them for 1 year you’ll pay income tax. If you hold them for 1 year you’ll pay capital gains tax (less than income tax).

4. They’re essentially worth nothing until there’s a liquidity event (IPO or acquisition). They have a “value” on paper, but if there’s no one to buy them, they’re worthless.

5. Your % gets diluted every time the company issues new shares.

6. Investors have a liquidation preference (they get their money before you do). So depending on the valuation of the exit, you may get little to nothing. Look out for preferences that give investors multiples on their investment.

7. NSO and ISO are taxed differently. Google it.

If stock options are a significant part of your comp package, you should educate yourself.


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