VIDEO: Founders University: Stock Options – Definitions and Key Terms

Welcome back to Founders University, our core curriculum designed to provide startup founders with the basics needed to launch a company while minimizing costly missteps or mistakes.

For our next session of Founders University, we share an overview of Stock Options – notably how related terms are used and defined. In this course, partners John Egan and Lynda Galligan talk about some of the definitions and common terminology that are used for stock options.

Ready. Set. Learn!

 

A stock option is the right to purchase a share of stock at a fixed price for a fixed period of time. Such an option could be, for example: to buy 1,200 shares of stock at a price of $1 dollar per share for up to 10 years.

Additional related terms include:

Exercise price – the fixed price at which the stock may be bought. For tax reasons, the exercise price is generally equal to the fair market value of the underlying stock on the date of grant.

Term – the length of time that the option can be exercised. It’s usually 10 years, but the term is typically cut short if the holder ceases to provide services to the company. Normally a vested stock option can be exercised for 3 months after termination.

Exercising (a stock option) – paying the exercise price and receiving the stock.

Spread – this refers to the appreciation in the fair market value of the underlying stock over the exercise price. An option with a positive spread is called “in the money,” and an option with a negative spread is called “out of the money,” or “underwater.”

Vesting – options are typically subject to vesting, meaning that holders earn the right to keep the option over time.

Unvested options – these options expire when service terminates.

Vesting schedule – a typical vesting schedule would be 4-year vesting; a one-year cliff, which means a quarter of the shares vest at the one year period; and monthly vesting for the following three years.

Performance-based vesting – unlike time-based vesting (as described above), under performance-based vesting the option vests upon meeting certain performance measures. These can include benchmarks such as the attainment of a certain level of earnings, or the release of a new drug.

Acceleration – when the vesting schedule is accelerated, the option is earned sooner.   Acceleration can often occur in connection with the change of control or sale of the company. Sometimes it’s negotiated in connection with the termination of employment.

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