October 14, 2026
A stock option gives the holder the right to buy a set number of shares later, at a fixed price (the exercise price), usually the fair market value on the grant date. Options typically vest over four years with a one-year cliff, and the holder pays nothing until they exercise. The value is the difference between the exercise price and what the shares are worth when they’re sold.
Key takeaways
Example: An employee has 10,000 options with a $1 exercise price. If the company is acquired at $5 a share, the options are worth the spread: 10,000 × ($5 − $1) = $40,000. There’s no public market for private company shares, so value usually comes from an acquisition, an IPO or an approved secondary sale.
A promise in an offer letter isn’t a grant. Only the board can grant options, and only to someone who is providing services on the day of the grant, so the board can’t approve options for a new hire before their first day or for someone who has already left. Many plans also don’t allow grants to an LLC or other entity, or to workers engaged through a PEO, so check the plan before promising options to anyone outside a normal employment or consulting relationship. See Promising Equity vs Issuing Equity.
Timing matters too. The exercise price is fixed on the day the board approves the grant, and the board can’t backdate it. If approval slips past a new 409A valuation, the employee can end up with a higher exercise price than they expected. The fix is to approve grants on a regular schedule, monthly or quarterly, for everyone who has started. Put any special terms, such as acceleration or a longer exercise window, in the board consent itself, because those terms need board approval just like the grant. And check the state securities filing requirements for each recipient’s state before the board approves the grant. For other compensation mistakes, see Startup Compensation Mistakes to Avoid.
Two ISO rules catch founders out. Anyone who owns more than 10% of the company’s voting stock, usually a founder, can receive ISOs only at an exercise price of at least 110% of fair market value and with a term of five years or less. And large grants, grants that vest quickly and early-exercisable grants can push part of a grant over the $100,000 limit, and that part is treated as an NSO. See NSO vs ISO.
Nothing is taxed at grant. For NSOs, the spread at exercise is taxed as income. For ISOs, the spread at exercise isn’t regular income but can trigger alternative minimum tax. Talk to a tax advisor before exercising. Some companies let holders exercise before vesting. See Early Exercisable Stock Options.
The company may not be worth more than the exercise price, shares can’t easily be sold until there’s an exit, and exercising can require cash for the price and the tax.
See our Stock Option Grant service.
