Kinds of Stock Options

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Kinds of Stock Options

Common questions covered here
What is the difference between statutory and non-statutory stock options?
What are the pros and cons of NSOs?
What are the pros and cons of ISOs?
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โ€‹Definitionโ€‹ Compensatory stock options come in two flavors, incentive stock options (ISOs) and non-qualifying stock options (NQOs, or NQSOs). Confusingly, lawyers and the IRS use several names for these two kinds of stock options, including statutory stock options and non-statutory stock options (or NSOs), respectively.

In this Guide, we refer to ISOs and NSOs.

TypeAlso called
StatutoryIncentive stock option, ISO
Non-statutoryNon-qualifying stock option, NQO, NQSO, NSO
  • Companies generally decide to give ISOs or NSOs depending on the legal advice they get. Itโ€™s rarely up to the employee which they will receive, so itโ€™s best to know about both. There are pros and cons of each from both the recipientโ€™s and the companyโ€™s perspective.

  • ISOs are common for employees because they have the possibility of being more favorable from a tax point of view than NSOs.

  • โ€‹cautionโ€‹ ISOs can only be granted to employees (not independent contractors or directors who are not also employees).

  • But ISOs have a number of limitations and conditions and can also create difficult tax consequences.

Early Exercise

โ€‹Definitionโ€‹ Sometimes, to help reduce the tax burden on stock options, a company will make it possible for option holders to early exercise (or forward exercise) their options, which means they can exercise even before they vest. The option holder becomes a stockholder sooner, after which the vesting applies to actual stock rather than options. This will have tax implications.

โ€‹cautionโ€‹ However, the company has the right to repurchase the unvested shares, at the price paid or at the fair market value of the shares (whichever is lower), if a person quits working for the company. The company will typically repurchase the unvested shares should the person leave the company before the stock theyโ€™ve purchased vests.

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