Glossary

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409a

An independent valuation to determine the fair market value of the company's common stock. Required by law, it's named after IRS Section 409 and happens at least every 12 months; any time your company raises a new ro und of funding; or anytime there is a significant event at the company that could impact the valuation. (As companies get closer to IPO, 409A appraisals happen more frequently.) If your company is public, the fair market value is determined by the public price per share on the date the option is issued.

AMT

AMT is a tax law designed to prevent wealthy taxpayers from using loopholes to avoid taxes. It works by expanding the amount of income that's taxable, and not allowing for standard deductions or any personal exemptions. AMT comes into play if you have incentive stock options (ISOs) — if you exercise ISOs but do not sell the stock in the year of exercise, the transaction is not taxable that year for regular tax purposes. However, the difference between the exercise price and the fair market value of the stock on the day of the exercise is an adjustment for AMT purposes. For many people, this adjustment can be a very large number, and means ISOs require particularly careful financial planning.

Cap Table

Otherwise known as "capitalization table." Basically, it's a summary of "who owns what" — according to Wikipedia, it's "an analysis of a company's percentages of ownership, equity dilution, and value of equity in each round of investment by founders, investors, and other owners."

Common Stock

Common stock is what people refer to when they mention stocks on the stock market — it gives you some ownership in a company, voting rights, and dividends if the company does well. However, common stockholders are on the bottom of the priority ladder in the ownership structure. For example, if the company undergoes a liquidation event, the payout order is usually: bondholders, preferred shareholders, other debt holders, and then finally common stockholders.

Dilution

The reduction in the ownership percentage of a company after new equity shares are issued. If your company raises more money and takes on more investors, they could issue more shares, and thus dilute the value of your shares. Your ownership will also be diluted when the company issues options or RSUs to attract new employees and/or retain old ones. But dilution isn't the end of the world — raising money to grow faster can make it worthwhile if it's meant to accelerate growth

Exercise Price

Same as the strike price.

Exercise Window

This is the period of time during which you can exercise your vested options at the strike price. If you fail to exercise your options within the exercise window, then you will lose your ownership of those vested stock options. After leaving a company, the clock will start ticking on your window to exercise the options you vested during your time there. The vast majority of companies give you 90 days from the day of your departure to exercise — so if you want to exercise, act fast.

FMV

Fair market value is the dollar amount that stock is worth on the open market. The taxes you pay when you exercise your options depend on the difference between the fair market value of your shares and the strike price you pay for them, often called the "option spread". You are always taxed on the option spread, and it's pretty straightforward: the bigger the difference, the more taxes you pay. (But the bigger the difference, the more money you make!)

ISO

A type of stock option that provides a tax benefit — on exercise, you don't have to pay ordinary income tax (but you may have to pay alternative minimum tax instead). If the shares are held for one year from the date of exercise and two years from the date of grant, then the profit made on sale of the shares is taxed as long-term capital gains.

Lock up period

The time following an IPO where employees can't sell their stock for up to 180 days (in most cases). It's meant to prevent employees from all dumping their stock and depressing the stock price.

NSO

Stock options which do not qualify for the same special treatment accorded to incentive stock options — NSOs trigger additional taxable income at the time of exercise, based on the difference between the exercise price and the fair market value on that date.

Preferred Stock

Preferred shareholders are guaranteed an income from dividends, and preferred stock comes with the right to preferential treatment in a liquidation event. Usually, venture capitalists receive preferred stock in the startups they invest in.

RSU

RSUs are shares of common stock subject to vesting, granted once you achieve certain performance milestones, or after you've remained with your employer for a certain length of time. You don't have to exercise or pay for the stock, but you do have to pay taxes when your RSUs vest — at that point, you have to report income based on the fair market value of the stock. RSUs are often found at later-stage, more mature companies.

Stock Option

Stock options give you a potential share in the growth of your company's value without any financial risk to you until you exercise the options and buy shares of the company's stock. Moreover, while cash bonuses and most other forms of compensation are taxable when you receive them, stock options defer taxes until you exercise them. Before you exercise your options, their built-in value is subject to pre-tax growth—which can be significant.

Strike Price

The fixed price at which you will be able to exercise (purchase) your options. Naturally, the lower the strike price, the better. (Note: Only a board of directors can set the strike price, so your grant and strike price will be confirmed at the next board meeting after you join a company.)

Vesting Schedule

The process by which you earn your shares over time. The typical vesting schedule is over four years with a one-year cliff — meaning that on your one-year anniversary, you will have vested 25% of your initial grant. After the cliff, your options will vest monthly until you are fully vested after four years. Vesting acceleration happens when your stock vests faster than the original schedule dictates — if your company gets acquired or participates in a merger.