When considering how to compensate employees, California and Idaho startups might want to consider offering stock options to their non-founder employees. Stock options are a type of equity compensation for employees that take the form of a contract. This contract allows employees to buy stock in the future at a set price per share (Exercise Price). The shares are not issued at the time the contract is signed, rather they are issued when the employee decides to exercise their option.
The exercise price is the price an employee will pay per share once they decide to exercise their stock option. This is usually set at fair market value of the stock the day the option is granted. The benefit to the employee is that if the company does well and the price of shares go up, the employee can then exercise their option and pay less per share than the fair market value on the day they exercise.
Stock options are usually subject to vesting. Vesting refers to a process or schedule which controls the rate that stocks are issued (see blog post regarding founders stock). However, vesting works differently with stock options than it does with founders stock. Rather than being issued the stock immediately upon vesting like with founders stock, with stock options the right to repurchase is phased out over time. Although vesting of founders stock and stock options is different, the effect is functionally the same: the equity is earned over time.
So how do stock options work as an employee of a start up? Stock options are considered a type of compensation from the employer. The company will give the employee stock options and determine the vesting schedule. Once the options vest, the employee can exercise their options by purchasing the stock at the exercise price. If the employee does not exercise their option, they have no equity.
Stock options are a good way for a startup to incentivize employees to perform at a high caliber to grow the company and to remain at the company while the options are still vesting. Stock options also allow the company to hire high quality employees they may not otherwise be able to afford.