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I am looking at a job offer and they are offering me the following equity package:

Equity: 14,000 stock options

Equity Breakdown: All equity goes on a 4 year vesting schedule, with a 1 year cliff. The numbers below show what the equity was most recently evaluated at (IMPORTANT!!!! Your numbers are subject to change because they are set and based on when you start with the company and if our board sets a new price.)

Most recent strike price for employees: $2.60

Most recent value per share: $ 12.75

Value per share: $10.15

$10.15 x 14,000 = $142,100 in Grant Day Value

So in practical terms, what does this mean? It sounds like in one year I get the option to purchase at a very low price 1/4 of 14,000 shares. Can I somehow put this in my 401k? Or do I just use this like regular stocks and hang onto it until I feel it's the right time to sell? Is there anything else special about this sort of thing?

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    Do you know if they are NQSO options or ISO options? – Lou Nov 3 '20 at 22:03
  • @Lou it didn't say – Yamikuronue Nov 4 '20 at 16:05
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Stock options represent the option to purchase a share of stock in the future at some specified price, which is called the "strike price". This price will be set when your options are granted, although you will have to wait until the options actually vest until you can exercise them (exercising an option means buying a share at the strike price). The strike price is often set as the market value on the day of the grant, although here it seems the strike price is set by the board explicitly. If the board sets the strike price below the market value, options have immediate value.

The strike price may or may not be a "very low price" depending on what the stock does in the future. If the stock price remains above the strike price, you retain the option to buy the stock at the lower strike price - this is great, since you can buy at the strike price and sell at the market price for an immediate profit. If the market price goes below the strike price, you are left with the option to buy the stock at higher than market price, which one would never do in practice - if the stock price falls below your strike price, you'd be better off buying a share from the open market rather than exercising the option.

The package example shows a rather lucrative stock option, where the market price is higher than the strike price - in the example, you are able to exercise an option to buy a share that's currently worth $12.75 for the low price of $2.60. This does not necessarily mean that your equity package will be worth a similar amount - if the stock price falls below the strike price, a grant of stock options is worth absolutely nothing. Compensation in the form of stock options gives the benefit of large potential gains, but they are risky in that they may ultimately be worth nothing. Having a board-set strike price that's below the market price at grant reduces the risk somewhat, since the options will be worth something the day they're granted, and will continue to have value even if the stock price doesn't move at all.

After options vest, you'll have some period of time (perhaps 10 years, check your plan specifics) in which you can exercise them to buy stock at the strike price. You can immediately sell that stock to earn the profit over the strike price (the $10.15 per share in the example), or you can hold onto the stock like you would any other share, and sell it at a later date to enjoy a lower, long-term capital gains tax (but then you risk the stock falling below what you paid for it).

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  • "if the stock price does not rise, a grant of stock options is worth absolutely nothing" - not true - at the time or award they are worth $10.15 x 14,000 = $142,100. If the stock price does nothing (neither rises nor falls), they are still worth that at the time of vesting. They're only worthless if the stock goes below the strike price. – D Stanley Nov 3 '20 at 19:29
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    @DStanley Hm, I was operating under the assumption that the strike price is simply the market value on the day the option is granted, which is pretty typical - in that case, an option only has value if the price goes up from the day it's granted. But after re-reading the question, it seems the board sets the strike price on its own, which could allow for a profit even with no change in stock price. Good catch. – Nuclear Hoagie Nov 3 '20 at 19:39
  • Depending on the type of option, there may also be differences in taxation depending on how long the OP holds the stock after exercising. – chepner Nov 3 '20 at 21:45
  • One thing I didn't quite understand before joining (they gave a huge talk about it as part of my onboarding) was that the stock wasn't public yet, so all this valuation is pre-IPO. Most people expect to buy their stock when the company has our IPO. Don't know if that changes your answer any – Yamikuronue Feb 24 at 22:48
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So in practical terms, what does this mean?

It means that part of your compensation will be in the form of stock options, or the option to buy stock on a fixed date at a fixed (strike) price. That stock gives you a (small) percentage of ownership in the company, that you can sell if the company goes public (if it's not already public).

It sounds like in one year I get the option to purchase at a very low price 1/4 of 14,000 shares.

The strike price is fixed, so as long as the value of those shares is more than $2.60 then yes, you'll be able to buy shares at a discount. If the value of the stock goes below $2.60 then your stock options are worthless (why would you buy stock at $2.60 when you could buy it for less?)

Can I somehow put this in my 401k?

Not directly, since you can only contribute to a 401(k) through salary deferral. But you could sell the stock once it vests and adjust how much you contribute to your 401(k) accordingly.

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    Technically, I believe that one cannot make direct cash contributions to a 401k account - they can only be funded by payroll deduction. Given that, your last line isn't quite accurate - although one could sell stock and use that while boosting payroll deduction to fund the 401k. Same basic effect but slightly more complicated process. – Istanari Nov 3 '20 at 18:59
  • @Istanari Good points - edited. – D Stanley Nov 3 '20 at 19:28
  • To be completely accurate, OP could increase their payroll deduction amount that is contributed to the 401k. Since you'd have the proceed from the stock to offset the loss of immediate income. I think that's what D Stanley meant. – JohnFx Nov 4 '20 at 14:51

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