Americans have a glorified imagining of start-up companies these days. Internet and software success stories have been mythologized as the ideal quick but hard-fought come-up for savvy young people. In pop culture, shows like Silicon Valley play up on the trope of nerdy could-be software billionaires; a new movie out later this month, The Intern, pits a retired-but-wide-eyed Robert De Niro against the apparently instant success story of Anne Hathaway; and, five years ago, The Social Network fabled the launch of Facebook. But despite our collective zeal, startups almost never last, and the frat-house-like work environment we sometimes see projected on the big screen is just as misleading, if not impossibly rare.
Still, there’s a reason narratives about successful startups are booming, and while the trend is current, it’s also a tribute to this country’s uniquely entrepreneurial tradition. Even though the odds of making it big as a startup founder or early-round employee are slim, the wide spread of freshly-launched businesses is constantly opening up new job pools. And while the risks involved with taking a position at a new business are probably obvious, it’s also worth planning for the potential of success. Many of us have a plan for negotiating towards a higher salary or better job benefits, but it’s rare—especially for millennials—to sit down and plot out the possibility of owning a small stake in a business you work for. The prospect of exercising an employee stock option can be daunting and complicated, but it doesn’t have to be a complete unknown.
With all of the above in mind, here are a few things you should know about startup equity and employee stock options.
- Remember: your equity might never amount to anything. Anytime you’re working towards equity at a just-launched company, and especially if you’re foregoing pay for points, you’re taking a big risk. The best case scenario—like, Hollywood make-it-big stuff—is that the startup becomes a runaway success and the company is either bought or goes public. But there’s always the obvious possibility of your equity stake folding with the rest of the company.
- So, what actually is an employee stock option? According to Forbes, “An employee stock option is a contract issued by an employer to an employee to purchase a set amount of shares of company stock at a fixed price for a limited period of time.” In other words: if you decide to exercise your stock options you’ll be buying shares at a fixed rate for employees.
- What is restricted stock? A stock option opens up a unique opportunity for an employer to purchase company shares, but restricted stocks are completely different. Instead of vesting and exercising your options, restricted stock refers to shares that are given to you by your employer. This is the arrangement you might encounter at a brand-new startup, and while the stock might be worth next-to-nothing to start, you’ll have longterm potential of your shares growing with the company.
- What’s a vesting schedule? The vesting schedule is one of the most important aspects to a stock option plan and determines when an employee can purchase their shares. In most cases, a vesting schedule prevents quick cash-outs by requiring an employee to work a certain period of time before their shares are vested. You might hear about a stock option with a vesting schedule of ten years with a two-year cliff, for example. That means that your promised stock options—maybe it’s 1,000 shares—will be made available to you over a ten year period following that initial cliff. The cliff distinguishes the first two years of employment (in this case) as exempt from the vesting period, so basically you have to put some time in before you’re allowed to start snatching up shares. Finally, vesting schedules also implement expiration dates, meaning your stock options are by no means available at a fixed price forever.
- Don’t forget about taxes. Just like your paycheck, any equity you buy or are granted counts toward your total income, and is just as taxable. Kind of. This is an area worth asking your employer about because the terms are different everywhere and largely dependent on the specifics of your equity plan, but you’ll also want to read up on the general rules of paying taxes for incentive stock options (or ISO’s) right here, via TheMuse.
