Employee Stock Options (ESOs) have become a widely used form of compensation, particularly in high-growth companies and startups. By granting employees the right to buy company shares at a set price, ESOs align employee interests with the success of the company. While they offer significant financial rewards if the company performs well, ESOs also come with risks and complexities that employees need to understand fully before deciding whether to accept them as part of their remuneration package.
What are employee stock options?
Employee Stock Options (ESOs) are contracts that allow employees to purchase company shares at a specific price, called the exercise or strike price, after a certain period, known as the vesting period. This set price is often lower than the market value, enabling employees to benefit financially if the company’s stock price rises above the strike price. ESOs are typically offered as a way to incentivize employees to contribute to the company’s growth and stay long-term.
What are the various types of employee stock options?
Employee Stock Options come in different forms, each with its own rules and tax implications. The two main types are:
- Incentive Stock Options (ISOs):ISOs are offered exclusively to employees and come with tax benefits if certain holding requirements are met. If the employee holds the stock for at least one year after exercising and two years after the grant date, the profit may be taxed at the lower capital gains rate rather than ordinary income rates.
- Non-Qualified Stock Options (NSOs):Unlike ISOs, NSOs can be granted to employees, consultants, and directors. These do not have the same tax advantages as ISOs, and the difference between the strike price and the market price at the time of exercise is taxed as ordinary income.
- Restricted Stock Units (RSUs):RSUs are a form of stock-based compensation where employees receive shares or their cash equivalent after meeting certain performance targets or completing a vesting period. RSUs do not offer the option to purchase shares but grant actual shares when conditions are met.
- Stock Appreciation Rights (SARs):SARs allow employees to benefit from the increase in the company’s stock price over time, without the need to purchase the stock. Employees receive the financial gain, either in cash or shares, from the stock’s appreciation over a specific period.