Employee Stock Options Explained

A stock option is a legal right granted by a company to an individual, letting them buy a set number of shares at a fixed price, called the strike or exercise price, at some point in the future. The exercise price is fixed at grant and does not change. The holder does not own shares and has no voting rights or dividend rights until they exercise the option and pay the strike price. If the company's share price rises above the strike price, the option has value; if it falls below, the option is worthless, or underwater.

Options are almost always subject to vesting, meaning the employee earns the right to exercise them gradually over time, usually contingent on continued employment. A grant of options is documented in an option agreement, which sets out the strike price, vesting schedule, exercise window and what happens if the employee leaves.

Options are attractive to early employees because they defer both the cash outlay and, in many regimes, the tax charge until the shares are worth something. Founders sometimes hold real shares from day one instead, since they can afford the up-front cost and want to start the clock on capital gains treatment early.

• UK: EMI (Enterprise Management Incentives) for qualifying small companies, or CSOP for larger ones, both offering capital gains tax treatment on exercise gains rather than income tax.
• France: BSPCE, warrants reserved for company creators and employees, taxed favourably compared to ordinary options, available only to companies under certain age and ownership conditions.
• Germany: options are typically structured as VSOP (virtual options, see phantom shares) because of dry income risk under Section 19a EStG, though real options exist and the Zukunftsfinanzierungsgesetz (Future Financing Act) has eased some rules since 2024.
• Netherlands: since 2023, employees can choose to be taxed at exercise (default) or, if shares are not tradable, defer the tax point to when shares become tradable, addressing dry income concerns.

Tax treatment depends on the specific scheme, company size, and individual circumstances. This is general information, not tax advice; employees should check their own position with a qualified adviser.

• Grant: the company issues an option agreement setting the strike price and vesting schedule.
• Vesting: the option becomes exercisable in tranches over time, commonly over 4 years with a 1 year cliff.
• Exercise: the holder pays the strike price to convert options into actual shares.
• Sale or exit: shares are sold, typically at an acquisition or IPO, realising the gain.