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I currently have an unpaid offer from a tech company, however, they have mentioned the following in the offer letter. Since, I am not aware of stock terminology, if someone can explain to me what this really means, that would be great:

Your initial compensation for the above mentioned work is in the form of a Non-qualified stock option grant, equaling 75,000 options, which vests straight-line and quarterly over a four-year period, as long as you are in our employ. As of the date of this letter, there are 3.02M issued stock plan shares.

Please explain to me what the above paragraph means in simple language, and since it's unpaid, will I have to pay taxes on the stocks next year?

I am currently located in California, United States.

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  • What country are you in?
    – Mike Scott
    Commented Sep 21, 2015 at 6:31
  • United States, California state.
    – John
    Commented Sep 21, 2015 at 6:32
  • @John I don't believe it is legal in California to not pay wages.
    – littleadv
    Commented Sep 21, 2015 at 7:57
  • But isn't it an unpaid work?
    – John
    Commented Sep 21, 2015 at 7:59
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    @John that may be, but unless you're a founder/executive - you have to be paid at least the minimum wage. That is the law, and you cannot give that right up. Even if you agree now, you may and should sue the employer later for back wages, but you better fix it now before it becomes a war. Options are by default worthless. Unless there's a huge success, you're not going to see any money from them. Statistics I know is that 1% of all startups don't close and go bankrupt, let alone become hugely sucsessful.
    – littleadv
    Commented Sep 21, 2015 at 16:46

2 Answers 2

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A little terminology:

  1. Grant: you get a "gift" with strings attached. "Grant" refers to the plan (legal contract) under which you get the stock options.

  2. Vesting: these are the strings attached to the grant. As long as you're employed by the company, your options will vest every quarter, proportionally. You'll become an owner of 4687 or 4688 options every quarter. Each such vest event means you'd be getting an opportunity to buy the corresponding amount of stocks at the strike price (and not the current market price which may be higher). Buying is called exercising. Exercising a nonqualified option is a taxable event, and you'll be taxed on the value of the "gift" you got. The value is determined by the difference between the strike price (the price at which you have the option to buy the stock) and the actual fair market value of the stock at the time of vest (based on valuations). Options that are vested are yours (depending on the grant contract, read it carefully, leaving the company may lead to forfeiture). Options that are not vested will disappear once you leave the company. Exercised options become stocks, and are yours.

  3. Qualified vs Nonqualifed - refers to the tax treatment. Nonqualified options don't have any special treatment, qualified do.

  4. 3.02M stocks issued refers to the value of the options. Consider the total valuation of the company being $302M. With $302M value and 3.02M stocks issued, each stock is worth ~$100. Now, in a year, a new investor comes in, and another 3.02M stocks are issued (if, for example, the new investor wants a 50% stake). In this case, there will be 6.04M stocks issued, for 302M value - each stock is worth $50 now. That is called dilution. Your grant is in nominal options, so in case of dilution, the value of your options will go down.

Additional points:

If the company is not yet public, selling the stocks may be difficult, and you may own pieces of paper that no-one else wants to buy. You will still pay taxes based on the valuations and you may end up paying for these pieces of paper out of your own pocket.

In California, it is illegal to not pay salary to regular employees. Unless you're a senior executive of the company (which I doubt), you should be paid at least $9/hour per the CA minimum wages law.

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  • A couple of minor points: a) The last sentence in 2 isn't necessarily true, for example, the first option grant notice I just looked at from my previous company provides a 3 month grace period after termination to exercise. b) In 4, if an investor is given a 50% stake in a $302M company, they're probably investing a significant amount of money, which increases the valuation of the company. The point about dilution is a good one, but it's not quite as simple as in the answer. Other than that it's a good, comprehensive answer.
    – blm
    Commented Sep 21, 2015 at 20:33
  • @blm grace period is for already vested options. As to the dilution, yes, my example is very simplistic, just to demonstrate the idea.
    – littleadv
    Commented Sep 22, 2015 at 2:13
  • Oops, you're right of course on the grace period only applying to vested options. Sorry.
    – blm
    Commented Sep 22, 2015 at 3:49
  • Actually, in your example the value of his options does not go down, it goes from $0 to $0.
    – David Schwartz
    Commented Dec 20, 2016 at 21:59
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Let's work from the inside out. Options are not stock. Options are a contract that give you the right to own the stock. For options to have value they have to be exercised. Straight line means that each quarter 1/16th of the option grant becomes yours and the company cannot take it away. Four quarters in a year times four years is 16 quarters. 'Grant' means they are giving you the options at no cost to you. 'Nonqualified' means that there is nothing you have to do, or be, in order to get the options. (Some options are only for management.)

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  • Do I have to pay any taxes on this?
    – John
    Commented Sep 21, 2015 at 7:50
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    Nonqualified means something else entirely.
    – littleadv
    Commented Sep 21, 2015 at 7:58
  • What does vest means? And when will it become vest?
    – John
    Commented Sep 21, 2015 at 8:00
  • @littleadv OK, what does 'Nonqualified' mean?
    – Jack Swayze Sr
    Commented Sep 21, 2015 at 8:59
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    @john I reread your original post. If you are being 'paid' options in lieu of wages then please consider the following: 1. There is no guarantee that the company would ever go public. 2 . The value of the options depend on the strike price. If they do not specify the strike price in your offer then they could set the strike price unusually high making your options worthless. 3. The options could have a very short expiration date making them worthless before you could excersize them. Normally, stock options are an incentive. I have received stock options from a company but I also got paid wages
    – Jack Swayze Sr
    Commented Sep 21, 2015 at 10:33

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