How Do Employee Stock Options Work?
Employee stock options (ESOs) are one of the most intriguing, yet misunderstood, forms of compensation in the startup world. They offer employees a unique opportunity to share in the financial success of the companies they’ve helped build. But navigating the world of ESOs can feel confusing and overwhelming, with technical jargon and tax implications unfamiliar to most people creating barriers for many employees.
Did you know that more than 55% of startup employees lose their hard-earned equity because they don’t fully understand the process,can’t afford to exercise their options or don’t want to take the financial risk? (Source: Carta). The good news is, you don’t have to be an equity expert to unlock the potential benefits of stock options.
This guide will walk you through what you need to know about ESOs, including how they work, the challenges involved, and how platforms like Equitybee can make exercising your options more accessible.
What Are Employee Stock Options (ESOs)?
To understand ESOs, let's break down some key terms:
- Stock Options: These give you the right to purchase shares of your company at a set price, called the exercise price or strike price, regardless of the company’s current valuation.
- Vesting: A process where your stock options are earned over time, typically over 4 years with a 1-year cliff. For example, if your options vest over four years with a one-year cliff, you’ll earn 25% of your options after the first year, and the remaining 75% gradually over the next three years.
- Grant Date: The date your company awards you stock options.
- Exercise Price: The pre-determined price at which you can purchase your shares.
- Expiration Date: The deadline to exercise your vested options, often set to 90 days after leaving a company.
- ISO vs. NSO:
- ISOs (Incentive Stock Options) are typically granted to employees and include favorable tax benefits, like deferred taxes under certain conditions.
- NSOs (Non-Qualified Stock Options) are available to employees, contractors, and other contributors, but they are taxed at the time of exercise.
Now that you’re familiar with the basics, let's take a closer look at how ESOs actually work.
How Do Employee Stock Options Work?
Here’s what a typical employee stock option process looks like:
1. Grant
You receive a stock option grant from your employer, detailing important terms like the number of options, strike price, vesting schedule, and expiration date.
2. Vesting Schedule
Your options vest over time, meaning they become exercisable in stages. Most commonly, this happens over four years with a one-year cliff. For example, if you’re granted 10,000 options, 25% (2,500 options) will vest after your first year.
The remaining 75% then vests gradually - usually monthly or quarterly - over the next three years.
If your option package is like the description above, then if you leave your company before completing one full year, you won’t vest any options at all.
3. Exercising Options
Once your options vest, you can “exercise” them by paying the strike price to convert them into actual shares. However, exercising can come with costs,including taxes,that can make this step financially challenging.
4. Selling Your Shares
Once your company goes public, is acquired, or has another liquidity event, you can sell your shares and (hopefully) realize significant financial gains.
While this process may seem straightforward, many employees face significant hurdles, especially when it comes to exercising their options.
The Challenges of Exercising ESOs
Exercising your stock options turns your equity into real ownership, but this step can also be one of the most difficult. Here’s why:
1. High Exercise Costs
Exercising stock options requires paying the strike price for all vested shares. Combined with potential taxes, this can pose a significant financial burden. According to Equitybee’s data, the average exercise cost for U.S. employees is approximately $140,000.
2. Taxes (AMT for ISOs)
For ISOs, exercising can trigger the Alternative Minimum Tax (AMT) on the spread between your strike price and the fair market value. For NSOs, you may owe ordinary income tax on the spread between your strike price and the fair market value at the time of exercise.
In some cases, the tax bill can exceed the actual cost to exercise your options.
Equitybee does not provide tax advice and advises you to speak with your tax adviser about your specific situation.
3. Opportunity Cost
Even if you can afford to exercise, tying up significant funds in equity can feel risky, as there’s no guarantee that your company will reach a liquidity event, or how long it will take.
These challenges often leave employees feeling stuck, risking expiration of their options. Fortunately, there are ways to fund your stock options without shouldering the financial risk alone.
Funding Solutions for ESOs
1. Personal Savings
Some employees use savings, but this approach could cut into your cash reserves for emergencies.
2. Loans
In some cases employees obtain personal loans to cover exercise costs, but this creates debt that they must repay, even if the company's shares lose value or the company never has a liquidity event.
3. Equitybee
This is where Equitybee comes in. Equitybee aims to connect startup employees with investors who fund the cost of exercising stock options,with no loans, no out-of-pocket expense, and no personal financial risk to exercise the options. This allows employees to exercise their options, while investors share in the potential proceeds if the company exits.
Quick Stat: As of May 2025, Equitybee has funded over $120M for more than 2,500 startup employees from companies like Reddit, SpaceX, Databricks, Stripe, and many more.
Through platforms like Equitybee, you don’t have to walk away from your options or risk your personal finances trying to exercise them.
Equitybee as a Solution
Here’s how Equitybee helps you exercise your options and become a shareholder:
1. How It Works
- Apply on Equitybee’s platform.
- Equitybee connects you with investors who provide the funding to cover your exercise and tax costs.
- Once funded, you exercise your options, becoming a shareholder without any upfront out of pocket cost.
2. Benefits
- No loans.
- No out-of-pocket costs.
- You retain ownership of your shares, only sharing a portion of future proceeds in the event of a liquidity event.
3. Companies Supported
Equitybee has helped employees from over 800 pre-IPO companies, including Reddit, SpaceX, Databricks, Plaid, and many others. Whether you’re leaving your job or planning ahead, Equitybee’s mission is that you don’t lose access to the equity you’ve earned.
By removing financial barriers, Equitybee empowers employees to take control of their options and secure their financial future.
Don’t Lose What You’ve Earned
Employee stock options represent more than just compensation; they’re an opportunity to share in the growth and success of your company. But without a clear plan, high exercise costs and limited time windows can threaten this hard-earned equity.
If navigating stock options feels overwhelming, platforms like Equitybee are here to help. With a non-recourse funding model, Equitybee has enabled thousands of employees to own their shares without taking on personal financial risk.
Taking the next step is easy. Learn more and see how Equitybee can help you unlock the potential of your equity today.
