Pricing strike levels from preferred share rounds
Most plans set the exercise price equal to the fair market value of the underlying share on the date of grant. For an unlisted startup, fair market value is usually derived from the price paid by investors in the most recent funding round, discounted to reflect that ordinary shares lack the preferences held by preferred shareholders, a discount that gets fixed in the option grant agreement itself.
For example, if preferred shares in the last round were priced at 10.00 EUR, ordinary shares used for options might be valued at 3.00 to 6.00 EUR after applying a discount for lack of preference rights and marketability, depending on the valuation method used, and this figure sets the strike price employees later pay when exercising options.
Measuring potential gains above the exercise cost
| Scenario | Strike price | Share price at exercise | Gain per share |
|---|---|---|---|
| In the money | 2.00 EUR | 8.00 EUR | 6.00 EUR |
| Break-even | 2.00 EUR | 2.00 EUR | 0.00 EUR |
| Underwater | 2.00 EUR | 1.00 EUR | negative, option not exercised |
An option only has value if the current share price exceeds the strike price. Rational holders do not exercise underwater options, since it means paying more than the shares are currently worth under any reasonable startup valuation.
Tax implications of pricing
- UK EMI: gains from strike price to sale price are typically taxed as capital gains, not income, if conditions are met.
- France BSPCE: gains are taxed at favourable rates depending on the employee's tenure at the company.
- Germany: setting a strike below fair market value can trigger an immediate benefit-in-kind tax charge, which is one reason virtual options are common.
- Netherlands: since 2023, employees can elect to defer taxation from exercise to the point shares become tradable, reducing dry income risk.
Tax rules change and depend on individual circumstances; this is general information, not tax advice.
Strike price questions worth clearing up
- Why not set the exercise price at zero?
- A near-zero strike price makes the option economically similar to a free share grant, which most tax-advantaged regimes do not treat as an option and which can trigger income tax at grant instead of capital gains treatment later.
- Does the exercise price ever change after grant?
- Generally no, though some plans allow repricing in specific circumstances such as a down round, subject to board and sometimes shareholder approval.
General information for founders, not legal or tax advice. Thresholds and rates change, so confirm the current position with an adviser in the relevant country before granting.