Stock Options: how they work

Stock Options: how they work

In the corporate world, stock options have become one of the most widely used tools for attracting, motivating, and retaining talent, especially in the technology sector and in fast-growing startups. They are based on a fairly simple idea: offering an employee the right, but not the obligation, to purchase shares in the company where they work at a specified price and at a future date, subject to the fulfillment of a series of objectives.

A thorough understanding of how they work is essential for both those who receive them as part of their compensation and those who offer them.

Stock options are, in essence, contracts that give an employee the opportunity to purchase shares in the company at a fixed price, known as the strike price. This value is set at the time the options are granted and does not change over time, regardless of market fluctuations. The underlying logic is the alignment of interests: if the company grows and the value of its shares increases, the employee will be able to purchase them at a lower price and potentially make a profit by selling them on the market.

How stock options work

These options work through a number of key components:

1. First, the number of shares associated with the grant is determined.
2. Then, the strike price is set, which is the cost the employee will have to pay for each share when they decide to exercise their right.

There is also a consolidation period known as vesting, during which the employee gradually acquires the right to exercise the options. It is common to establish a four-year horizon, with a first tranche called a cliff, which is usually one year, during which if the employee leaves the company, they lose all their options. Finally, every stock option has an expiration date, usually between seven and ten years, after which it expires and is no longer valid.

Benefits of this incentive mechanism

The appeal of this instrument lies in the fact that it generates advantages for both companies and employees. For organizations, stock options act as a powerful retention mechanism, as those who hold them have a direct interest in remaining with the company until they consolidate their rights and see the value of their shares increase. At the same time, they become an element of strategic alignment: the better the company performs, the more both partners and employees will benefit. In addition, they allow young companies, which often have liquidity constraints, to offer competitive compensation without having to allocate large amounts of cash to salaries.

From the employees’ perspective, stock options represent an opportunity to participate in the company’s success, with the possibility of generating significant gains if the company’s value increases. Added to this is a greater sense of belonging and commitment, as by becoming partners, employees feel that they are an active part of the collective results. Likewise, for those who join startups with lower starting salaries, stock options serve as an attractive salary supplement that offers medium- and long-term rewards.

However, stock options also involve risks and disadvantages that should not be overlooked. Their value depends directly on the company’s performance; if the company does not grow or if its shares fall, the options may become worthless. In terms of taxation, the tax treatment varies from country to country. In some cases, taxes are applied when the options are exercised, and in others when the shares are sold, which can significantly reduce the net profit.

The relevance of stock options also varies depending on the type of company. In startups, they are practically standard, as they allow companies to compensate with future value what they cannot always pay in present salaries. This is where much of their appeal lies: if the company grows rapidly or goes public, the potential for appreciation is considerable.

In contrast, in established and publicly traded corporations, they are often part of the compensation packages for managers and senior executives, although they also extend to other levels of the organization. In these cases, the risk is usually lower, but so is the potential for value multiplication.

In conclusion, stock options are an innovative tool that allows the value and future of a company to be shared with those who contribute directly to building it. They function as a link between individual effort and collective success, but they do not represent a guaranteed benefit. Well designed and understood, they can become a unique opportunity for companies and employees to grow together, strengthening both the corporate culture and the economic potential of those who participate in it.