Ask HN: How exactly do stock option grants work?

Yes, but most people don't exercise their options until a liquidity event (company gets sold, goes public, etc). When this happens, you hope the shares are worth more than your option price. If so, you can exercise your options and make profit between your option price and the current price. This is the zero risk way to do it.

Also it looks like it will take five years to vest, so what happens if the company is acquired/goes public between now and then?

You should have some sort of vesting schedule in your packet. I'm guessing that within 5 years all your options will be vested, but between now until then, your options vest as you work. This is because your startup doesn't want to just give out boatloads of options to people who are going to leave. They want you to stick around and earn them and the vesting schedule is how they accomplish that.

You basically have the "option" to purchase the stock for a set price (your strike price) for some period of time.

Yes, to exercise your options you would have to purchase the stock at the strike price, and then sell it at the current (higher) price. With few exceptions, you can't do any of this until/unless the company IPO's and is publicly traded.

Because you have not been granted anything of direct value (that would be a stock grant, not an options agreement), you have no tax liability, because, well you don't have anything :)

5 Years is a bit rough, a typical vesting schedule is 4 years, typically with a 1 year cliff (nothing vests until you reach 1 year of employment, then 25% (or in your case probably 20%) of the shares are vested, meaning you could exercise them. After this, a proportionate amount of additional shares vests each month until the 4 or 5 year mark).

If something happens to the company before the 5 year period, some combination of losing any/all shares (vested or not), getting new/additional shares, getting an entirely new allocation of shares, or having the strike price adjusted is likely to happen.

You don't actually own anything until you exercise (buy) the shares. And I HIGHLY recommend you don't purchase any of the vested shares until the company is public, and only then when you intend to exercise them immediately (which is generally a cashless transaction).

The hard facts are that until there is an IPO, common stock (what you have options to) is very likely to get whacked around a fair bit, and you stand to lose far more than you gain.

Now, it's been a while since I've had to think about any of this, but I'll try to answer your questions:

ISOs (Incentive Stock Options) are options that do not carry a tax burden. Meaning, if you exercise your options (purchase them at the strike price) you do not have to pay taxes on any profits you make on them.

Common stock is called common to differentiate it from preferred stock which is typically given to investors, founders or to purchase board members. The primary difference being is if your company goes under, those guys get taken care of first.

Vesting periods usually work like this:

You have a cliff -- which is, essentially, a time gate that says "if you leave before date x, you get no shares. after date x, you are able to purchase all of the shares you earned prior to date x (in your case probably 12/60ths of total allotment) and earn the right to purchase an additional 1/60th of your options every month thereafter."

What happens if you are acquired? There are several possibilities depending on the type of acquisition.

1) You might be given a new grant

2) You might be given cash in exchange for vested shares and a new grant based on the pool of the parent company

Going public I'm less familiar with, but I'm under the impression that you can unload any stock you own onto the market barring any contractual agreements (CEOs and significant shareholders, if I recall correctly, are disallowed from divesting over a certain amount per month so as not to affect valuation).

In addition to exercising your options during a liquidity event it's common that a company requires you to either exercise or expire your options when you leave the company. There's typically a time period allowing you to decide to exercise these or not, often it's 30 days after you leave that you have available to decide to purchase your options or not.

You've been given options, not actual stock. This should not concern you. The difference between options and stock is largely a tax matter. In both cases, you've received an instrument with a very low current price that will be lucrative to you if the price appreciates (in, for instance, a takeover).

When you leave the company, you'll be required to shell out some cash to keep your exposure to the company's upside; you didn't give numbers, but if you stay until you're mostly vested, expect it to cost a couple thousand dollars. You'll have to decide whether the company's prospects merit the investment.

If the company is sold before you leave, you won't have to exercise your options in advance (you'll still need to exercise them, but this will be a no-brainer since the stock value will have appreciated). The difference between leaving and staying with respect to your options is risk.

As with every company, your options vest, meaning they become available to you in waves on a vesting schedule. This should not concern you; even the founders in your company have a vesting schedule.

What happens when the company is purchased? It depends. If you're lucky, there is a company-wide change-of-control clause that gets you instant access to the upside of the sale. You're probably not that lucky. The most likely outcome is that you'll have a mostly locked-in upside, but that you'll have to work through the remainder of your vesting schedule to get it. There are lots of sticky details (such as what happens if you're terminated before you vest after a change of control), but it's a waste of time to worry about them now.

You didn't ask, but do know: as employee 50+N in a 100+K-person startup, you are extremely unlikely to get any concessions in the terms and conditions of your equity grant. The company's board reviewed and agreed on this plan; it is a big deal to change it for anyone.

The real question is the company valuation and its financing terms. You should have been informed as to what % of the common stock your grant works out to, so you can work out what an $Xmm acquisition means to you. You should also probably be able to find out what the liquidation terms are on the company's financing (how much of that X the company's investors take off the top before the common stock is valued). These are the numbers that differ most wildly from job to job, and the ones most likely to impact your personal upside.

Remember that as a line employee in a 100 person startup, your stock grant is not going to be a life-changing event unless the company is CNN-level spectacularly successful. If the company does quite well, it'll probably amount to the equivalent of a 5-figure bonus per year, paid in a lump sum when the company is bought.

Once I left the company with some vested options, bought them for about 500 bucks, and then got washed out in their next round of investing.

Once (like you I was employee 65 in a 70 person company) we got bought for a nice sum, and the employees all got retention packages worth, as tptacek noted, 5 figures per year served, give or take. Most of the early-in employees, who put in very long hours at the beginning, felt a bit screwed. They worked out their hourly rate for overtime spent on the company, and it came out... okay. Not great. Late arrivals like me felt just fine.

The main point I've taken from these experiences is this: when grunts like us own shares in a private company (or options to buy shares), we don't own anything real. What we own is a small piece of a partnership contract, in which we are a very underprivileged partner. If you look carefully in the partnership agreement, you will see that not all shares are created equal. There are A class, B class, C class, and so on. Each class of shares enjoys different privileges w/r to the money that comes into the company. Grunts like us get C class shares that place us at the mercy of the other two classes.

Investors and founders are senior partners in the company, and they can pretty much do what they want with your part of the contract. Your only remedy is to quit the company.

Some things companies commonly do with shares of this class:

- Take a new round of investment, and rip them up. Often this happens after a down round of fund raising. With layoffs in advance. The laid off employees lose all interest in the company (even if they bought their shares!), and the remaining employees get issued new options in the new agreement.

- See them replaced with some other incentive plan. This usually happens after a medium sized exit. Basically the buyer puts a certain amount of money on the table. The board of the company splits up the pie in some way that sort of relates to the current share agreement. Then they wash out all of the existing shares and hand out retention packages to employees and founders. The size of the packages typically relates to the size of your grant, but few people get cheques cut on the day of the sale. Most have to work for a year or two to see the payout.

Let me sum up with this: I'm not bitter! I've got way less risk in the game than investors and founders, especially as a late arrival. This is the reality of the game, and my eyes are wide open. So equity participation in a small company for me is icing on the cake. Far more important is base salary, benefits, HR policies, company culture, technology, co-workers, all that stuff. I've never chosen one company over another based on the options package. For grunts like us it rarely matters anyway.