Negotiating Stock Options

Employers use stock options as an effective recruitment and retention incentive for senior or hard-to-fill positions. It's flattering to be offered stock options, but without clear understanding, they can be hazardous to your financial health.

Options give you the right to purchase a set amount of stock in the company at a predetermined price (usually attractive) and over a fixed period of time. Employees are typically offered Incentive Stock Options. With this type of option, you only have to pay taxes on your gains when you sell the stock; and if you keep the stock for at least a year after the purchase, you will not have to pay capital gains tax.

When negotiating stock options, always bear in mind that they are a gamble. The employer is going to talk about the offered stock options as if they were money in the bank; they are not. Stay focused on the current market value of the stock, especially if you are asked to accept options in lieu of salary, you can't eat stock options.

With a publicly traded company, learning the value and performance of stock is a matter of public record. If the company is privately held, your judgment equals your faith in the company, the immanence of their going public, and whether the company is a start-up or a well established entity.

With private companies, you'll want to consider market segment, business strategy, operations, liquidity and senior management track record very, very carefully. If the stock options do not impact your take-home pay, it can't hurt to get as many as you can, because there is a big difference between getting the options and actually exercising your right to buy and sell them. Your considerations will include: what the purchase price will be, when you can exercise your options, and the restrictions on when you can buy and sell the stock. These matters will be laid out in the separate Options Agreement; read it carefully with advice of counsel or accountant before you start negotiating.

Stock options always have a vesting period. This is the length of time you must work for the company before you can exercise your options (read buy the stock). The employer will want the vesting period to be as long as possible, thus tying you to the company. You, on the other hand, will want to shorten the vesting period.

Ask to get an Incremental Vesting Schedule, which allows you to buy a few shares every month or quarter. It will probably get you fully vested in the same period of time, but in smaller more frequent steps along the way. Also ask for Accelerated Vesting in the event your employer merges or is bought by another company. This way, you become fully vested at the time of the acquisition.

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