Document Guide

Stock option agreement
IN PLAIN ENGLISH

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A stock option agreement is the contract between a company and an employee (or contractor or advisor) that grants the right to purchase shares of the company's stock at a fixed price in the future. Stock options are a form of equity compensation, designed to align your interests with the company's success: if the company does well and the stock price rises, your options become valuable. If the company fails or the stock price stays flat, your options may be worth nothing.

Options are common in startups and tech companies, where cash compensation is often below market and equity is used to attract talent. The pitch is that you're trading salary today for potential upside tomorrow — if the company goes public or is acquired at a high valuation, your options could be worth a lot. The reality is more complicated: most startups fail, most options never pay out, and even successful exits can leave employees with less than they expected due to dilution, liquidation preferences, and tax surprises.

Understanding your option agreement is essential because the details determine whether your equity is actually valuable. How many shares? At what strike price? When do they vest? What happens if you leave? What are the tax implications of exercising? A stock option grant that sounds generous on paper can be worth far less — or far more — than you think, depending on these terms.

Common clauses in a stock option agreement

  • Grant of options

    The number of shares subject to the option and the date of grant. This is the headline number — "you're getting 10,000 options" — but it's meaningless without context. What matters is your percentage ownership (which depends on the total shares outstanding) and the potential value at exit (which depends on the company's future valuation).

  • Type of option: ISO vs. NSO

    Whether the options are Incentive Stock Options (ISOs) or Non-Qualified Stock Options (NSOs). ISOs have favorable tax treatment if you meet certain holding requirements — you may owe no tax on exercise and pay capital gains rates on sale. NSOs are taxed as ordinary income on the spread between the strike price and fair market value at exercise. ISOs are only available to employees; contractors and advisors get NSOs.

  • Exercise price (strike price)

    The price per share you'll pay to buy the stock when you exercise. This is set at the fair market value (FMV) on the grant date, as determined by a 409A valuation. A lower strike price means more potential profit if the stock price rises. The strike price is locked in — it doesn't change even if the company's value goes up.

  • Vesting schedule

    The timeline over which you earn the right to exercise your options. The standard vesting schedule is four years with a one-year cliff: you earn nothing until you've been at the company for 12 months, then 25% of your options vest at the cliff, and the remaining 75% vest monthly (or quarterly) over the next three years. If you leave before the cliff, you get nothing.

  • Vesting acceleration

    Provisions that accelerate vesting in certain scenarios. "Single trigger" acceleration means your options vest immediately upon a change of control (acquisition). "Double trigger" means acceleration requires both a change of control and your termination (usually within 12-24 months). Double trigger is more common; single trigger is more employee-friendly.

  • Exercise period

    How long you have to exercise vested options after you leave the company. The standard is 90 days after termination — if you don't exercise within 90 days, your vested options expire worthless. Some companies offer extended exercise windows (1-10 years) as a benefit, but most don't. This 90-day window can force a difficult decision: exercise and pay cash (plus taxes) for illiquid stock, or walk away from vested equity.

  • Early exercise

    Whether you can exercise options before they vest. Early exercise lets you start the capital gains holding period sooner and potentially reduce taxes under Section 83(b), but it requires paying for unvested shares that you might forfeit if you leave. If early exercise is allowed, you must file an 83(b) election within 30 days of exercise to get the tax benefit.

  • Method of exercise

    How you pay for the shares: cash, cashless exercise (sell some shares immediately to cover the cost), net exercise (the company withholds shares equal to the exercise price), or stock swap. The available methods depend on whether the company is public or private and what the plan allows.

  • Restrictions on transfer

    Whether you can sell or transfer your options or the underlying shares. Options are almost never transferable. Shares acquired upon exercise are typically subject to restrictions: a right of first refusal (the company can buy back your shares before you sell to a third party), a lock-up period around an IPO, and potentially a repurchase right if you leave the company.

  • Right of first refusal (ROFR)

    A right for the company to buy back shares you want to sell, at the price offered by a third-party buyer. This prevents you from selling on the secondary market without the company's involvement and can delay or block liquidity.

  • Clawback and repurchase rights

    Whether the company can repurchase your shares (vested or unvested) in certain circumstances, such as termination for cause. Some agreements allow the company to repurchase vested shares at the lower of exercise price or current FMV, which can wipe out your gains.

  • Termination provisions

    What happens to your options when you leave. Unvested options are typically forfeited. Vested options must be exercised within the post-termination exercise window (often 90 days). Termination "for cause" may result in forfeiture of all options, even vested ones, or repurchase of exercised shares.

  • Section 409A compliance

    A statement that the option is intended to comply with Section 409A of the Internal Revenue Code, which governs deferred compensation. Non-compliance can result in harsh tax penalties. The strike price must be set at FMV based on a proper 409A valuation.

  • Governing plan documents

    A reference to the company's equity incentive plan, which contains additional terms and conditions. The option agreement is governed by the plan, so you need to read both documents.

Red flags to watch for

  • Strike price higher than expected

    If the strike price is significantly higher than you expected — perhaps because a new 409A valuation was done after your offer letter — your potential upside is reduced. Ask what FMV was at your grant date and how it compares to recent financing rounds.

  • Short post-termination exercise window

    A 90-day exercise window can force you to make an expensive decision quickly if you leave. You may have to pay the exercise price plus taxes for illiquid stock that you can't sell. Some companies offer longer windows; if yours doesn't, factor that into your decision.

  • No acceleration on change of control

    An agreement with no single-trigger or double-trigger acceleration means your unvested options may be cancelled or cashed out at the acquirer's discretion in an acquisition. You might get nothing for options that hadn't yet vested.

  • Clawback for termination "for cause"

    A clause that allows the company to cancel vested options or repurchase exercised shares if you're terminated for cause. The definition of "cause" matters — an overly broad definition could let the company take back your equity for minor infractions.

  • Repurchase at exercise price, not FMV

    A repurchase right that lets the company buy back your shares at the original exercise price (not current FMV) if you leave. This means you lose any appreciation since exercise.

  • NSOs instead of ISOs

    If you're an employee receiving NSOs instead of ISOs, you're getting worse tax treatment. ISOs are better in most scenarios (assuming you can meet the holding requirements). Ask why ISOs aren't being used.

  • High percentage of unvested shares in the company

    If a large portion of the company's shares are unvested (subject to future vesting by employees and founders), your percentage ownership will be diluted as those shares vest. Ask about the fully diluted cap table.

  • No early exercise option

    Without early exercise, you can't start the capital gains clock until options vest. This may result in higher taxes if the company's value increases significantly before you can exercise.

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// This is not legal advice // Plain-English summary generated by AI // Always read the original document