Employee Stock Option
The term employee stock option (ESO) refers to a type of equity compensation granted by companies to their employees and executives. Rather than granting shares of stock directly, the company gives derivative options on the stock instead. These options come in the form of regular call options and give the employee the right to buy the company's stock at a specified price for a finite period of time. Terms of ESOs will be fully spelled out for an employee in an employee stock options agreement.In general, the greatest benefits of a stock option are realized if a company's stock rises above the exercise price. Typically, ESOs are issued by the company and cannot be sold, unlike standard listed or exchange-traded options. When a stock’s price rises above the call option exercise price, call options are exercised and the holder obtains the company’s stock at a discount. The holder may choose to immediately sell the stock in the open market for a profit or hold onto the stock over time.
Employee Stock Option (ESO)
Definition
An Employee Stock Option (ESO) is a form of equity compensation granted by companies to their employees and executives. Instead of directly granting shares, the company provides stock options. These options take the form of standard call options, giving employees the right to purchase company stock at a specified price within a limited period.
Origin
The concept of Employee Stock Options originated in the mid-20th century and was widely adopted by tech companies in the United States. With the rise of Silicon Valley, many startups began using ESOs as a tool to attract and retain talent. Through ESOs, employees can share in the company's growth and success, motivating them to contribute to the company's long-term development.
Categories and Characteristics
Employee Stock Options are mainly divided into two categories: Incentive Stock Options (ISOs) and Non-Qualified Stock Options (NSOs).
- Incentive Stock Options (ISOs): These options are typically granted only to employees and come with tax advantages. No ordinary income tax is due upon exercise, but capital gains tax is due upon the sale of the stock.
- Non-Qualified Stock Options (NSOs): These options can be granted to employees, directors, and consultants. Ordinary income tax is due upon exercise, but only capital gains tax is due upon the sale of the stock.
Specific Cases
Case 1: John works at a tech company that grants him 1,000 ESOs with an exercise price of $10 per share. Two years later, the company's stock price rises to $20 per share. John decides to exercise his options, purchasing 1,000 shares at $10 each, costing him $10,000 in total. He then sells these shares at $20 each, earning $20,000 and making a net profit of $10,000.
Case 2: Jane works at a startup that grants her 500 ISOs with an exercise price of $5 per share. Three years later, the company goes public, and the stock price rises to $15 per share. Jane decides to exercise her options, purchasing 500 shares at $5 each, costing her $2,500 in total. She chooses to hold onto these shares long-term, hoping for further price appreciation.
Common Questions
1. What is the exercise price?
The exercise price is the price at which employees can purchase the stock when they exercise their stock options.
2. How are ESOs taxed?
The tax treatment of ESOs varies by country and region. Generally, ordinary income tax may be due upon exercise, and capital gains tax may be due upon the sale of the stock.
