Glossary - Stock Option
A stock option is a financial derivative that represents a legal agreement by which an employee, investor, or service provider obtains the right but not the obligation to buy a certain number of shares in a company at a predetermined price, known as the strike price, before a specified expiration date. Stock options are commonly used as compensation to employees and executives in startups and established companies alike, to align their interests with the growth of the company.
Also known as
- Equity options
- Share options
- Employee stock options (ESOs)
Use cases examples
- Employee Stock Option Plan (ESOP) Agreement: Under this ESOP agreement, the grantee is entitled to exercise the option to purchase 1,000 shares of the Company's common stock at a strike price of $10 per share within five years from the date of grant.
- Venture Capital Term Sheet: The term sheet stipulates the allocation of 15% of the post-money equity in the form of stock options set aside for the company's future employee stock option pool.
Considerations for investors
- Evaluating the potential dilution effect of stock options and how it affects the valuation of their investment.
- Understanding the terms and conditions of the stock options, including vesting schedules, to assess the long-term motivation and retention of key personnel.
Considerations for founders
- Determining the size of the stock option pool and its impact on dilution of ownership.
- Setting appropriate strike prices for options to make them an attractive incentive for employees while safeguarding the interests of existing shareholders.
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