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What Are Stock Options

Lecture 12 - Bonus Tracks -> Quick Intro -> How Much Technology Knowledge Must A Beginner Tester Have -> What To Do If You Are The First Test Engineer At A Software Start-Up -> What If You Are Asked To Do Test Automation As Your First Task -> What Are Stock Options -> How To Spot A Promising Start-up

Please note that I’m just giving you a GENERAL IDEA about employee stock options in the United States. Educate yourself and talk to your lawyer and tax advisor. Seriously.

An employee stock option is the right to buy a company stock (also called a share) at a fixed price under certain circumstances.


Here is the most obvious way you can make money with employee stock options (let’s just call them “stock options”):

– Let’s say you receive a stock options grant to buy 5000 stocks at $3 each.

– Four years after you joined the company, it went public.

– Today your company stock is being traded at $17 per share.

– You log in into your online brokerage account and do an exercise-and-sell transaction when the expense of buying shares ($15,000) is covered by the proceeds from the sale of 5,000 shares at $17 apiece ($85,000):

Your expenses = $15,000 (5,000 shares x $3)

Your pretax income = $70,000 ($85,000 – $15,000)

That 70K is a gift from your company to you. In this example, you don’t have to invest a cent of your own money. How cool is that!

Brain Positioning

The initial employee stock options grant refers to the stock options given to you when you become a permanent employee. This grant is negotiable before you put your signature on the job offer. When fortunes are made by regular software engineers, they are usually made with an initial stock options grant.

The fixed price of the stock option ($3) is called the exercise price.

What about “certain circumstances”? Let’s look at the vesting schedule.

The vesting schedule is a set of rules and conditions under which your stock options become exercisable; i.e., eligible to be converted into the shares.


Your company gives you 9600 stock options as an initial stock options grant with a vesting schedule over 4 years. There are 48 months in 4 years, and you might expect 200 stock options per month (9600/48) to be potentially vested. But it doesn’t work this way. Instead:

– 25% of your 9600 stock options (2400) are vested in a lump sum after one year of being an employee

– 200 options are vested each month over the next three years of your employment

If you quit

– before the end of one year, you’ll have no stock options to exercise

– after one year, you can exercise only 2400 stock options

– after one year and one month, you can exercise 2600 stock options

If you don’t quit, in four years you will be fully vested.

But there is much more to the “certain circumstances”: expiration of the stock options grant, blackout periods, various restrictions to trading, etc. My advice to you is this:

1. Understand whatever you sign (stock options grant document, job offer, etc.).

2. Keep yourself informed about your stock options and related matters.

3. Heavily educate yourself on stock option related matters.

4. Talk to professionals (lawyers and accountants).

This all sounds obvious, doesn’t it? Well, we all know that the history is full of examples when people get in trouble because of not doing obvious things.


During one seminar on stock options, the lecturer told a story about a woman who lost about $120,000 by not doing an obvious thing like paying attention to the stock options grant document.

Here’s what happened. The stock options grant expires

– several years after it was granted or

– several months after an employee leaves the company (whichever happens first)

So, that woman (let’s call her “Erin”) left the company for another job on May 2, 2007. According to her stock options grant document she had 90 days after she left the company to exercise her stock options. After 90 days the options expire; e.g., turn into nothing. Having all the signed documents, the use of Google search engine, and lots of financially savvy friends, Erin didn’t know about that 90 days condition. She was happy that the company stock grew like crazy, and she decided to convert her stock options into shares once the stock price reached $100 a share. On August 15th, after the stock finally hit $100, Erin logged into her brokerage account and was devastated by the simple word to the right of her stock options grant ID: “Expired.” THAT must have hurt! And it hurts even more if you realize that the situation could have been prevented just by paying attention to the document related to that huge amount of money.


In our examples, we’ve been looking at the situation when a company is public. What if it’s not, i.e., a company is private? Then the same rules about “certain circumstances” apply, plus there is the complication that you have to spend your own money to buy company shares: e.g., using figures from our first example, this would be $15,000. Now, what if you are going to leave a company that has not gone public where you have some stock options vested:

– On the one hand, your stock options will expire if you don’t exercise them, and you can lose potential profits.

– On the other hand, what if you invest your money and the start-up eventually dies in peace (along with your hopes to get nice return on your investment)?

There is no universal advice about right actions in this case. It all depends on your financial situation, the economy, how much you believe in the company, etc. In many cases, this is a HARD choice to make.

Now, let’s talk about acceleration of vesting. Acceleration of Vesting (AoV) is a time machine where you put your vesting schedule. Acceleration of vesting is triggered by certain events. The most common case that triggers acceleration is “a change in control of the company.” When someone buys our start-up, there is a change of control.


Let’s imagine that you have a standard four-year vesting schedule with a one-year acceleration clause in case of acquisition. Your first day at work is July 15, and your company is “suddenly” acquired the next day, July 16. So what happens? My friend, you hit a jackpot! It means that 25% of your stock options are now exercisable.

I’ve heard a story about one developer who signed a job offer and immediately went to vacation. In a couple of days, his manager called him and told him the company got acquired by another company and that this developer became millionaire because 25% of his stock options got vested.

As you can see, AoV is really important and, if it’s not offered, you should try to negotiate it.


Some companies don’t allow any AoV, because a start-up with AoV for its employees might look less attractive to investors. The reason is that an investor might worry that after the acquisition the employees will just cash out and run from the new owners like a deer runs from a “friendly” pack of hungry wolves. Investors have good reason to worry about this. Silicon Valley remembers many stories when the new owners did nothing but a damage to the acquired company. Next ->

Lecture 12 - Bonus Tracks -> Quick Intro -> How Much Technology Knowledge Must A Beginner Tester Have -> What To Do If You Are The First Test Engineer At A Software Start-Up -> What If You Are Asked To Do Test Automation As Your First Task -> What Are Stock Options -> How To Spot A Promising Start-up