Working for a startup often means taking on a little bit more uncertainty in exchange for a potentially brighter future.
You might be putting in long hours to help grow a company that you think will be the next Amazon, Netflix, or Uber. And you might have accepted a slightly lower base salary than you could’ve received at a more established company.
The possible upside? Employee stock options.
Ideally, you can exercise your stock options and sell the resulting shares for a potential windfall if the value of the underlying shares has increased since your options were granted. The more the company (i.e., its share price) grows, theoretically the more you can earn.
Still, stock options carry risks, and they can be costly to exercise. You might not have the funds available to convert your options into actual shares, or you may choose not to self-fund the exercise cost.
The good news is that employees often have several ways to afford to exercise options. Stock option loans or other forms of financing can potentially help you afford to exercise your options. After that, you could look to sell them for cash, hopefully at a sizable profit.
How does exercising stock options work?
When you receive employee stock options, you gain the right to buy company stock at a given price, known as the exercise price or strike price. However, you won’t actually own the stock underlying the options unless you exercise this right. Generally, stock options also have a vesting schedule, where the longer you’re at the company, the larger the percentage of your granted stock options vest (i.e., can be exercised).
So, while you might have negotiated a compensation package that includes a large chunk of stock options, any value the options have might be locked up until you can exercise them and then sell the resulting stock.
To exercise stock options, you pay the exercise price for each option you’d like to convert into a share of stock.
Suppose you’ve vested 5,000 stock options with a $10 per share strike price. That means you’d have to come up with $50,000 to convert your stock options into actual shares. While you’d then have 5,000 shares of stock, even if the value of the shares is above $10 per share, you wouldn’t realize that potential gain unless and until you can sell your shares.
There’s also no guarantee that the shares will build or retain value, and the timeline for selling shares can be unpredictable. You might have to wait several years to be able to sell your shares on the open market, even if you have nearer-term cash needs.
