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How Stock Options Work in VC-Backed Firms

It’s good news when venture capital finds your company good enough to invest in. That’s when your boss will likely create an option pool for the employees she wants to keep. And since more tech firms are seeing venture capital investment, the likelihood of top talent receiving stock options is growing as well.

The amount of venture money invested is rising, jumping 12 percent in the third quarter, and tech firms saw a big chunk of that money. Investment in software companies exceeded $3 billion for the first time in 12 years, according to the MoneyTree Report from PricewaterhouseCoopers. The sector’s companies also scooped up the majority of VC deals, and represented some of the largest investments of the quarter.

Get the Facts

If your company decides to offer up stock options, what’s the meaning for you? According to Sam Wu, partner at the Innovation Capital Law Group and blogger at TechStartupLawyer.com, employee stock option plans are meant to keep the top employees and management committed to the company. “The most important thing is the energy it creates when you incentivize employees with stock options,” he says.

Options are issued at what’s called a strike price — usually the par value of the shares at the time. You have the “option” to buy the stock at a later date, once the option is vested. The idea is that the company will be on an uphill climb, and the option will increase in value at the point when you decide to buy the stock. So, if you have options at $10, and the share price rises to $15, you keep $5 when you sell the stock.

“The typical vesting schedule of an option holder in a tech start up is four years,” says Wu. “If the employee leaves, the typical option agreement gives you 60 to 90 days to exercise any vested options.” When an option is “vested,” it means you can exercise it. Before vesting, all you can do is hold it.

Here’s the Good News

Now, there’s always a possibility that the company – even if it’s got venture money — will limp along or fail. When that happens, your options will have little to no value. But the beauty of getting stock options in a VC-backed deal is that the industry has given a seal of approval to the company. A tech firm with VC investment is generally a surer bet to survive. And, remember, VCs always have an exit strategy of selling to a bigger company or taking the company public. “The likelihood of getting acquired is higher with a VC pulling strings,” says Wu. “That’s a great thing for option holders.”

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About Myra Thomas

Myra Thomas is an award-winning business reporter. She started her career in finance, eventually becoming AVP for a Lloyd’s of London intermediary. She applies her extensive business knowledge to the world of reporting. Her stories run the gamut of topics, including tech, banking, healthcare, personal finance, and small business. She has a BA from Vassar College and an MFA from Fairleigh Dickinson University. Myra lives in Fanwood, New Jersey with her husband, two daughters, and two fierce Cairn Terriers.