To capture top engineering talent, startups often create competitive benefits packages. Benefits may run the gamut from health insurance to paid time-off to some form of stock. Specifically, startups may incentivize their remote teams by offering a stock option program.
Many remote engineers may be hearing the term “stock option” for the first time and don’t yet understand the value of this benefit. Essentially, employee stock options (ESOs) may be a lucrative opportunity for remote engineers if the startup is successful in the long run –especially if it goes public or is acquired.
To help remote engineers navigate this benefit, our expert team at Nexton has put together the ultimate guide to ESOs, including what employee stock options are, how to exercise them and how they could make you some big bucks.
- What are employee stock options?
- Success stories of stock option plans
- Key details of ESO
- Types of ESO
- Why would I want ESO?
- Turning stock options into cash
- When should I exercise my employee stock options?
- What happens if you get fired or quit?
- Equity vs. Employee Stock Options
- Benefits of ESOs for remote employees
- Leverage Employee Stock Options as a remote engineer
- Bonus: Terms to know
What are Employee Stock Options?
ESOs are all about the future. As part of a benefits package, employee stock options grant a team member the right to buy a specific amount of shares of company stock at a pre-set price, within a specified time.
Startups offer these plans to share the upside of the company value with the most critical team members. The value of the stock tends to go up significantly as the company grows, creating value for those team members who have ESOs. Finally, when at some point companies have a Liquidity Event (going public or getting acquired), equity holders have the opportunity to sell the stocks and turn them into cash.
Needless to say, everything concerning stocks is risky. This means there’s no guarantee the team member will make a great deal of money from their ESOs, but they just might, in the case the company is successful.
Success stories of stock option plans
There are countless examples of workers earning thousands and even millions by exercising their stock options. Big-name successes include Google, Disney, Pinterest, and GE.
Remember: if the startup you work for experiences a Success Event, you too can enjoy a windfall through stock options.
Key details of ESOs
To put this into perspective, if an employer gives you 10,000 ESOs, you do not own 10,000 shares of that stock. You have the option of buying those 10,000 shares at a price determined when you sign your letter accepting the employee stock option. Buying ESOs is known as exercising your option.
Remember that your employee stock options may not be available to you until you’re fully vested in the company. Even if a startup offers you the right to buy 10,000 ESOs, you may not be eligible to purchase all of them until you’ve been at the company for at least 4 to 5 years. Typically, you vest your stock over time and unlock more ESOs as you continue to work at the company.
Types of ESOs
SOs granted by employers are also separated into two categories. They can either be Incentive Stock Options (ISOs) or Non-Qualified Stock Options (NSOs), and they differ based on how and when they are taxed.
It’s worth noting that ISOs may qualify for special tax treatment under the United States Internal Revenue Code. Many companies pick this option when offering this benefit to their team members, because it may result in lower taxes. However, ISOs are typically not available for non-US persons.
Why would I want ESOs?
As your company’s stock value rises, your ESO remains at a pre-set price called a strike price or exercise price. This means during a Success Event, you can buy stock at a low rate and potentially make a profit by selling them in the future.
Let’s look at an example: Sophia is offered 10,000 ISOs at a strike price of $1 per share. She’s worked at the company for five years and is fully vested, meaning she’s eligible to exercise her right to all 10,000 ISOs. Lucky for her, the company she works for goes public and trades at $15 per share. If Sophia exercises her right to all 10,000 shares, she would buy them at the price of $10,000, but they would be worth $150,000. In other words, Sophia could sell her stock for a profit of $140,000.
It’s important to note that in this scenario, the initial trade price of the stock ($15) was much higher than the initial strike price ($1). However, if a startup doesn’t succeed, this stock price could be lower instead. If the trade price when the company goes public falls below the strike price, say $0.5 per share, for example, Sophia may not gain any value from the ESOs. Or even worse, maybe she had decided to exercise the stock options and she could end up losing money ($5,000).
Turning stock options into cash
Many remote engineers want to know how to turn ESOs into cash. The ability to earn through ESOs will depend on a startup’s Liquidity Event. Here are some ways team members can cash out:
- The company goes public through an IPO: This is usually the best-case scenario. You can simply exercise your options and sell the stock through the public market.
- The company is acquired: Your ability to cash out will depend on the acquisition terms. In the best case, you’ll be able to cash out or get your options transferred to the acquiring company. In the worst case, they could become worthless.
- You could sell your shares on a secondary market: Most employee stock option programs forbid this, so check the fine print. If allowed, you can put your shares up for sale on a platform such as Forge.
- Your company buys back your SO: Sometimes companies will do this, but it’s rare.
When should I exercise my employee stock options?
Remember that exercising your employee stock options can be expensive. In the example above, Sophia required $10,000 to buy the stock before selling it at $150,000. Before you exercise SO, you should take a good look at your personal finances and tax implications.
Typically, exercising your employee stock options before the company goes public has the best tax implications, but it’s very expensive and has certain risks if the company doesn’t do well. (Remember that Sophia lost $5,000 when she bought her stock options and the public trade price was lower than expected.)
Exercising your options after a company goes public or is acquired is usually the most affordable option. In this case, you can be certain of a profit when you see the public trade price. And if the buying price is too high for you, you may be able to get a loan in order to cover the initial purchase, which is paid back immediately after you sell it at a profit.
What happens if you get fired or quit?
If you decide to quit your job one day, you will have a shorter time to determine if you want to exercise your stock options. It’s usually up to 90 days, but it can also be less time. This is called the “time to exercise” your stock options.
For example, if you leave your remote job in May, it means you would potentially have until August to exercise your stocks. However, some agreements will allow for less time, which is one of the many reasons you must understand the specifics of your contract.
Equity vs. Employee Stock Options
As you consider your stock options, it’s important to be aware of the difference between ESO and equity. Remember that stock options mean you have the right to purchase a predetermined number of shares for a set price. You may or may not choose to purchase them. Only if you buy them will you start to hold equity in the company.
Generally speaking, equity means holding some ownership of a company. When you buy shares, you gain some level of equity in the company. Calculating your equity, however, will depend on how many shares have been issued by the company.
Benefits of ESOs for remote team members
SOs can be beneficial for all types of team members, and they are a great way to line up earnings for the future. Moreover, they are an excellent way for remote team members to be in on the company's success.
No barrier to entry
For remote engineers, access to ESO plans is even more beneficial. For starters, using employee stock options doesn’t require much work. Sure, there will be some decisions to be made initially, but you don't need to be a financial expert. They require almost no work on the part of the holder to maintain, which can be a barrier between many people and the stock market. Employee Stock options make this a non-issue.
Instill pride in work
ESOs are also great because they can give a team member a sense of pride in their job. Even though the stock options are not directly related to job performance, having potential part ownership of a company can help make remote teams feel important and appreciated, which in turn leads to more passion for the job.
Share in the company’s success
It’s also beneficial because remote workers can sometimes feel separated from everyone else in the company. When their employer decides to offer employee stock option plans, it shows that everybody is part of something much bigger – making them feel like they’re working towards a new goal for the business.
Leverage Employee Stock Options as a remote engineer
ESOs are one of the numerous benefits of being a remote software engineer. ESOs allow a team member to purchase a certain amount of stock at a specific price at a future date. It may sound odd to some, but most team members love it. It provides flexibility while also inspiring pride in one's work.
There’s a great deal to learn about employee stock options, but this guide should ease any hesitation. While they’re not a fit for every single team member, there’s a reason why so many remote engineers gladly accept ESOs as a form of compensation.
Be sure to ask your employer about their stock options plans and leverage this possibility as part of your benefits package. Good luck!
Bonus: Terms to know
As with anything in the financial world, you should know certain concepts related to ESOs. Consider this your glossary of terms to help make the process easier.
Exercise price or Strike price: The exercise price, also known as the strike price or grant price, refers to the pre-set price at which your employee stock options plan specifies you can buy the stock. To put it simply, it’s the specified price at which you will buy the shares of company stock offered to you.
Issue date: The issue date is the date on which the shares are first issued by the company. In other words, when the employee stock option is given to you. It also means the date hereof.
Shares: This word gets used quite a bit, but most people are not fully aware of what it means. Shares are, technically, units of stock. They are the smallest denomination of a company's stock.
Time to exercise: As you may guess, this is the time in which you are finally able to exercise your vested ESOs. The time to exercise happens after the predetermined vesting period, and once you’ve hit your vesting cliff. It’s worth keeping in mind that the time to exercise is usually shortened in cases of termination. Typically, team members only have 30 to 90 days to exercise an option after being terminated or quitting.
Vesting: Vesting is the process of earning the right to buy the pre-set amount of shares. The term is typically associated with time. Usually, a person will be told that they can purchase their stock options after a certain amount of time. This would be their vesting period. During this time, you can grow within your company.
Vesting cliff: A vesting cliff is basically when a team member becomes fully vested at a specific date in time, unlike becoming partly vested in gradual increments over a pre-scheduled time. In other words, it’s when the vesting period is over and you’ve earned the right to buy the shares. For example, you might arrange to become fully vested after, say, three years. Or you might arrange to be partially and gradually vested in growing amounts over a predetermined period.