Stock option plans: Overview, definition, and example
What is a stock option plan?
A stock option plan is a benefit program that gives employees the right to buy company shares at a fixed price, usually lower than the market rate. This allows employees to share in the company’s success if its stock value increases.
For example, a company might grant an employee the option to buy 1,000 shares at $10 per share. If the stock price rises to $20, the employee can purchase the shares at the lower price and sell them for a profit.
Why is a stock option plan important?
Stock option plans help businesses attract and retain employees by offering a financial incentive tied to company growth. When employees own a stake in the business, they are more motivated to contribute to its success.
For startups and growing companies, stock options can also be a way to offer competitive compensation without increasing salary costs. Employees benefit from potential financial gains if the company performs well, while businesses strengthen their ability to retain talent.
Understanding stock option plans through an example
Imagine a software company that offers stock options as part of its employee compensation package. A new hire receives an option grant for 5,000 shares at $5 per share, with a four-year vesting schedule. This means:
- Year 1: 25% of the options vest (1,250 shares)
- Year 2: Another 25% vest (1,250 shares)
- Year 3: Another 25% vest (1,250 shares)
- Year 4: The final 25% vest (1,250 shares)
By year four, if the company’s stock price has increased to $15 per share, the employee can buy shares at $5 and sell them at $15, making a profit. However, if the stock price stays below $5, the employee may choose not to exercise their options.
An example of a stock option plan clause
Here’s how a stock option plan clause might appear in an employment agreement:
“The Company may grant stock options to eligible employees under its Stock Option Plan. The number of options, vesting schedule, exercise price, and other terms shall be determined by the Board of Directors and outlined in the employee’s stock option agreement.”
Conclusion
Stock option plans give employees a financial interest in the company’s success. They can be a valuable tool for businesses looking to attract and retain talent while aligning employee incentives with long-term growth.
For employees, understanding how stock options work—including the vesting schedule, exercise price, and market conditions—is essential before making financial decisions.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.