Stock options can change your life. However, they can also feel like a foreign language cooked up by financiers and lawyers to give you a headache. 

Learning the basics helps you make smarter decisions, avoid costly mistakes, and better understand what your ownership could actually be worth over time. 

A Quick Guide to Equity  

What do those terms that you commonly see in offer letters and grant documents, or hear in conversations with HR actually mean? And how do you get from grant to equity ownership? We break it down for you here:

First Things First

• Stock Option: The right to buy stock at a fixed price (the strike price).

• Common Stock: At a startup, stock options typically confer the right to buy common stock. This is the type of stock with the fewest rights and protections, and is worth less (and is less marketable) than the preferred stock that investors buy.

• Fair Market Value (FMV): The independently-produced and board-approved value of a startup’s common stock. It is typically reassessed yearly, or after major events (e.g. a funding round). The strike price of a newly-granted stock option is always the FMV at the time of the grant.

The Mechanics: How It Works

• First, vest. The most common vesting schedule includes a one-year “cliff” after which you’ve earned the right to exercise the first 25% of your stock option grant. Once you’ve hit that cliff, you’re in the game. 

• Second, decide if exercising could make sense. For your options to have any real value – even if just on paper! – your startup’s FMV (its value today) must have increased past your strike price (what you have to pay to access that value). If that’s not the case, choosing to exercise is a bit of an eyebrow-raise.

• Third, decide if exercising does make sense. Exercising your options costs money. Not only do you have to pay the strike price, but the exercise itself is considered a taxable event, so you may also have to come up with money for the taxes associated with the on-paper gain between your strike price (what you’re paying for the stock) and the current FMV (what the stock is actually worth, now). And “how much money do I need” is only one piece of the overall decision – for the fuller set of considerations, check out this blog.

If you’re just as curious about what your equity is worth today, check out our equity valuation tool, the Vestimate

This material has been prepared for informational purposes only and is not intended to provide, and should not be relied on for investment, tax, legal, accounting, or other professional advice. Vested does not provide investment, tax, legal, accounting, or other professional advice. You should consult your own investment, tax, legal, accounting, or other professional advisors before engaging in any transaction or equity decision.