Exercise Stock Options:
Definition and How It Works

Clients Rate Lawyers on our Platform 4.9/5 Stars
based on 4,036 reviews

Jump to Section

Need help with a legal contract?

CREATE A FREE PROJECT POSTING
Post Project Now

What Does Exercising Stock Options Mean?

Employees that receive stock options as part of their compensation package will hope to exercise them one day in the future. Exercising stock options means purchasing the option stock granted to you at the exercise price , grant price , or strike price , which means you now own common stock of the company. Prior to exercising your stock options, you did not technically own common stock in the company.

The reason you would hope to exercise your shares is because they would have increased in value since they were granted to you. In other words, you stand to make a profit when you exercise your shares since you will be paying a lower price per share (exercise price) than the present-day value.

It does not always make sense to purchase option shares, though. If, for example, the present value of the shares hasn’t changed since the issue date, you may not want to spend the money to purchase them. The company may have also gone out of business, which means the shares are worth zero. Exercising stock options can also have a big impact on your taxes, so it is import to have a plan.

Here is an article about employee stock options.

How Exercising Employee Stock Options Works

Before considering whether it makes sense to exercise stock options, it is important to understand how they work. Employee stock options are used as a tool by employers to hire, retain, and motivate employees to work in the best interest of the company.

In other words, if the employee works hard to create value at the company, they should benefit in the increasing share price in the future. Hiring is also competitive, so if you want to hire the top talent you may need to offer employee stock options.

Here is an article about when you should exercise your stock options.

Understanding Basic Stock Options Terms

  • Exercise Price – The exercise price, also known as the grant price or strike price, is a price set by the issuer that reflects the fair market value of the stock. This is also the price the employee will be able to purchase, or exercise , their stock options in the future.
    • Example for Exercise Price: An employee may issue stock options at an exercise price of $0.50 per share. If the employee ever chooses to exercise the stock options after they have vested, he will hope the stock price is much higher than $0.50 per share, since he will have the ability to buy the options at $0.50 per share even if they are now worth $20 per share.
  • Grant Date – The grant date is the day the issuer of the stock options grants them to the employee. This date is typically listed on the stock options agreement the employee signs as part of their employment contract.
    • Example for Grant Date: If an employee signs an options grant on January 1, 2020, the grant date is most likely January 1, 2020 since it will be listed on the agreement and become legally binding upon signature.
  • Number of Shares – The number of shares is the number of stock option shares the issuer is granting to the employee. These are the shares the employee may have the opportunity to buy in the future.
  • Exercise Method – The exercise method is the way the employee will be required to pay for the shares in the future, should the employee choose to exercise them. Cash and stock swaps are two forms of exercise methods.
  • Vesting Schedule – The vesting schedule outlines the timeframe the employee will need to stay with the company in order to earn the right to buy the options.
    • Example of Vesting Schedule : It is very common to see a four-year vesting schedule with a ‘one year cliff’. This essentially means:
      • All stock will be vested after four years of service at the employer.
      • The employee needs to work a minimum of one year for any stock to vest.
      • After one year of service, the remaining stock will vest incrementally on a monthly or quarterly basis.
    • Expiration Date – The expiration date is the day which the employee will no longer have the ability to buy the option shares. This is typically years after the grant date.

Here is an article on vesting stock.

Meet some lawyers on our platform

Jonathan M.

1 project on CC
View Profile

Matthew S.

2 projects on CC
View Profile

Daniel R.

11 projects on CC
View Profile

Ryenne S.

135 projects on CC
View Profile

Exercising Example With Numbers

Now that we’ve gone over the key terms for employee stock options, let’s go over an example that explains how exercising works.

  • Joyce is hired at a new startup and is offered 10,000 option shares at an exercise price of $1 per share.
  • Joyce’s vesting schedule is four years with a one-year cliff, after one year the remaining shares vest monthly at 1/36.
    • In short, Joyce needs to stay the company for one year to get any shares at all. If she leaves before, she will have no option shares. After one year, 2,500 shares are vested, after two years 5,000 shares have vested, after 3 years 7,500 shares vested, and after four years she will have all 10,000 shares vested.
  • Joyce ends up staying at the company through all four years, so earns the right to exercise the 10,000 shares if she wants to.
  • The company is then purchase for a price of $10 pe share. This is a great result for Joyce!
  • Joyce will likely choose to exercise her stock options and buy all 10,000 shares at $1 per share (exercise price), so paying a total of $10,000.
  • In return, Joyce receives 10,000 shares which were currently valued at $10 pe share, meaning they are now worth $100,000.
  • Doing simple match, Joyce has earned a $90,000 profit ($100,000 - $90,000).

Here is an article that has another example of how exercising stock options work.

ContractsCounsel Exercising Stock Options Employee Image

Image via Pexels by Adam Nowakowski

Types Of Stock Options

There are two different types of employee stock options, which are below:

  • Incentive Stock Options (ISO) – ISOs are stock options that have the ability to qualify for preferential tax treatment. For this reason, ISOs are also known as qualified stock options.
  • Non-qualified Stock Options (NSOs) – NSOs are the most common and, as their name infers, do not qualify for special tax treatment from the Government.

Here is an article where you can read more about incentive stock options.

Here is an article where you can read more about non-qualified stock options.

Stock Options At Startups

Employee stock options are commonly offered as part of compensation packages for early employees. Startup founders want early employees to work as hard as possible to make sure the startup is a success, and there is no better way of doing that then allowing them to enjoy the upside if the startup becomes super successful.

Exercise prices can often be very low for startup stock options since the shares are worth very little at the beginning of a startup’s life. This allows for potentially huge returns by early employees.

Exercising Stock Options After Leaving Company

Many people jump from startup to startup and often leave a startup with some options vested. You can only exercise your stock options before your past employer’s post-termination exercise period ends. Once this period end, you will no longer have the ability to exercise your options and they simply go back into the company’s option pool.

Here is an article on startup stock options.


Get Free Bids to Compare

Leverage our network of lawyers, request free bids, and find the right lawyer for the job.

Get Bids Now

How Stock Options Are Taxed

The most important thing to remember is you become liable for taxes once you exercise your options. Prior to exercising, you do not need to pay taxes on your stock options because you do not own them. Your tax rate will be dependent on what type of options you hold.

  • Non-qualified stock options : NSOs are taxed at ordinary tax rates.
  • Incentive stock options : ISOs qualify for preferential tax treatment and can be taxed as capital gains rates.

If you want to better understand tax implications for your options, feel free to browse our tax lawyers .

Here is an article that has a table with the difference in tax liability between ISOs and NSOs.

Who Can Help With Stock Options

If you have any questions about exercising your options or employee stock purchase plans, feel free to post a project and receive free bids to review your agreement from qualified lawyers.

How ContractsCounsel Works
Hiring a lawyer on ContractsCounsel is easy, transparent and affordable.
1. Post a Free Project
Complete our 4-step process to provide info on what you need done.
2. Get Bids to Review
Receive flat-fee bids from lawyers in our marketplace to compare.
3. Start Your Project
Securely pay to start working with the lawyer you select.

Meet some of our Lawyers

Paul S. on ContractsCounsel
View Paul
5.0 (7)
Member Since:
August 4, 2020

Paul S.

CEO
Free Consultation
Get Free Proposal
Cincinnati, OH
37 Yrs Experience
Licensed in CA, OH
Boston University

I focus my practice on startups and small to mid-size businesses, because they have unique needs that mid-size and large law firms aren't well-equipped to service. In addition to practicing law, I have started and run other businesses, and have an MBA in marketing from Indiana University. I combine my business experience with my legal expertise, to provide practical advice to my clients. I am licensed in Ohio and California, and I leverage the latest in technology to provide top quality legal services to a nationwide client-base. This enables me to serve my clients in a cost-effective manner that doesn't skimp on personal service.

Davis S. on ContractsCounsel
View Davis
5.0 (1)
Member Since:
August 16, 2020

Davis S.

Founder
Free Consultation
Get Free Proposal
Minneapolis, MN
20 Yrs Experience
Licensed in MN
Mitchell Hamline School of Law

Davis founded DLO in 2010 after nearly a decade of practicing in the corporate department of a larger law firm. Armed with this experience and knowledge of legal solutions used by large entities, Davis set out to bring the same level of service to smaller organizations and individuals. The mission was three-fold: provide top-notch legal work, charge fair prices for it, and never stop evolving to meet the changing needs of clients. Ten years and more than 1000 clients later, Davis is proud of the assistance DLO provides for companies large and small, and the expanding service they now offer for individuals and families.

Terence B. on ContractsCounsel
View Terence
5.0 (29)
Member Since:
August 22, 2020

Terence B.

Partner
Free Consultation
Get Free Proposal
Orlando, FL and New York, NY
12 Yrs Experience
Licensed in FL, NY
Georgetown University Law Center

Terry Brennan is an experienced corporate, intellectual property and emerging company transactions attorney who has been a partner at two national Wall Street law firms and a trusted corporate counsel. He focuses on providing practical, cost-efficient and creative legal advice to entrepreneurs, established enterprises and investors for business, corporate finance, intellectual property and technology transactions. As a partner at prominent law firms, Terry's work centered around financing, mergers and acquisitions, joint ventures, securities transactions, outsourcing and structuring of business entities to protect, license, finance and commercialize technology, manufacturing, digital media, intellectual property, entertainment and financial assets. As the General Counsel of IBAX Healthcare Systems, Terry was responsible for all legal and related business matters including health information systems licensing agreements, merger and acquisitions, product development and regulatory issues, contract administration, and litigation. Terry is a graduate of the Georgetown University Law Center, where he was an Editor of the law review. He is active in a number of economic development, entrepreneurial accelerators, veterans and civic organizations in Florida and New York.

Jeff C. on ContractsCounsel
View Jeff
4.9 (3)
Member Since:
July 31, 2020

Jeff C.

Outside General Counsel / Business Attorney
Free Consultation
Get Free Proposal
Colorado
36 Yrs Experience
Licensed in CO, OR
University of Oregon

Experienced and broad based corporate/business attorney and Outside General Counsel (OGC), for start-ups, small businesses and growing companies of all sizes, advising and assisting clients with corporate and LLC formation, contracts and agreements, internet and terms of use/service agreements, trademarks and intellectual property protection, the purchase and sale of businesses (M&A), labor and employment matters, compliance and risk management, corporate governance, and commercial leasing matters. See other reviews on my website at www.ogcservices.net/reviews

Matthew S. on ContractsCounsel
View Matthew
4.9 (8)
Member Since:
August 5, 2020

Matthew S.

Attorney
Free Consultation
Get Free Proposal
Flemington, NJ
39 Yrs Experience
Licensed in NJ, NY
Benjamin N. Cardozo School of Law (Yeshiva University)

I am a 1984 graduate of the Benjamin N Cardozo School of Law (Yeshiva University) and have been licensed in New Jersey for over 35 years. I have extensive experience in negotiating real estate, business contracts, and loan agreements. Depending on your needs I can work remotely or face-to-face. I offer prompt and courteous service and can tailor a contract and process to meet your needs.

Tim E. on ContractsCounsel
View Tim
4.9 (33)
Member Since:
August 12, 2020

Tim E.

Founding Member/Attorney
Free Consultation
Get Free Proposal
Cleveland, OH
9 Yrs Experience
Licensed in OH
Cleveland-Marshall College of Law

Tim advises small businesses, entrepreneurs, and start-ups on a wide range of legal matters. He has experience with company formation and restructuring, capital and equity planning, tax planning and tax controversy, contract drafting, and employment law issues. His clients range from side gig sole proprietors to companies recognized by Inc. magazine.

Christopher J. on ContractsCounsel
View Christopher
Member Since:
August 3, 2020

Christopher J.

Attorney and Counselor at Law
Free Consultation
Get Free Proposal
Ann Arbor, MI
24 Yrs Experience
Licensed in MI
Detroit College of Law at Michigan State University

Experienced attorney focusing on estate planning, probate administration, business formation and counseling, and consumer bankruptcy.

Curt L. on ContractsCounsel
View Curt
Member Since:
August 13, 2020

Curt L.

Business Attorney
Free Consultation
Get Free Proposal
Houston, TX
33 Yrs Experience
Licensed in TX
South Texas College of Law Houston

For over thirty (30) years, Mr. Langley has developed a diverse general business and commercial litigation practice advising clients on day-to-day business and legal matters, as well as handling lawsuits and arbitrations across Texas and in various other states across the country. Mr. Langley has handled commercial matters including employment law, commercial collections, real estate matters, energy litigation, construction, general litigation, arbitrations, defamation actions, misappropriation of trade secrets, usury, consumer credit, commercial credit, lender liability, accounting malpractice, legal malpractice, and appellate practice in state and federal courts. (Online bio at www.curtmlangley.com).

Braden P. on ContractsCounsel
View Braden
Member Since:
August 18, 2020

Braden P.

Partner
Free Consultation
Get Free Proposal
Kansas City, MO
21 Yrs Experience
Licensed in KS, MO
University of Kansas School of Law

Braden Perry is a corporate governance, regulatory and government investigations attorney with Kennyhertz Perry, LLC. Mr. Perry has the unique tripartite experience of a white-collar criminal defense and government compliance, investigations, and litigation attorney at a national law firm; a senior enforcement attorney at a federal regulatory agency; and the Chief Compliance Officer/Chief Regulatory Attorney of a global financial institution. Mr. Perry has extensive experience advising clients in federal inquiries and investigations, particularly in enforcement matters involving technological issues. He couples his technical knowledge and experience defending clients in front of federal agencies with a broad-based understanding of compliance from an institutional and regulatory perspective.

William F. on ContractsCounsel
View William
Member Since:
August 18, 2020

William F.

Attorney
Free Consultation
Get Free Proposal
Denver, CO
17 Yrs Experience
Licensed in CO
University of Wyoming

William L Foster has been practicing law since 2006 as an attorney associate for a large litigation firm in Denver, Colorado. His experience includes drafting business contracts, organizational filings, and settlement agreements.

Find the best lawyer for your project

Browse Lawyers Now

Want to speak to someone?

Get in touch below and we will schedule a time to connect!

Request a call