Offer Letter: What does “option to purchase” shares mean?

Question

This is the first offer I have got. I do not understand a word about stock options. Please explain this to me:

Subject to the approval of the Company’s Board of Directors or its Compensation Committee, you will be granted an option to purchase 5,000 shares of the Company’s Common Stock (the “Option”). The exercise price per share of the Option will be determined by the Board of Directors or the Compensation Committee when the Option is granted. The Option will be subject to the terms and conditions applicable to options granted under the Company’s 2012 Stock Plan (the “Plan”), as described in the Plan and the applicable Stock Option Agreement. You will vest in 25% of the Option shares after 12 months of continuous service, and the balance will vest in equal monthly installments over the next 36 months of continuous service, as described in the applicable Stock Option Agreement.

One thing that I am confused is "the option to purchase" the stock. Does this mean I have to "buy with my own money" the stock or the company will give it to me?

Answer 1

I will add that there are significant tax complications when exercising option grants. As just one example, if you exercise when the stock price is above the exercise price but you don't sell the stock, you have AMT taxable income for the implied income that is the difference between the stock price and the exercise price. If the stock then tanks you end up paying tax for an investment you made little or no money on. Zafarullah, definitely read the whole option grant and when they vest, consult an expert or do some extensive research. Option grants can be valuable since they give you the option to buy at a favorable price, but they can be tricky to maximize the benefit.

Here's one reference: https://blog.wealthfront.com/when-to-exercise-stock-options/

Answer 2

You are given the options. At or after the vesting date, you can use your own money to buy the stocks at the exercise price. Typically you would only do this when the actual stock price is higher than the exercise price, and you would buy and the immediately sell the stocks. You would have to pay tax on the profit but sometimes it is possible to have the broker make all the transactions in one go, so you don’t give them $x and then get $y (>x) back, you effectively briefly borrow $x from the broker and then get $y-$x given to you.

Edit: I should have clarified that you do not ever have to exercise the options, so you never have to spend your own money if you don’t want to. They are literally giving you the option to purchase.