"In a typical vesting schedule, it will take four years of employment for your options to become fully vested."

What is stock option vesting?

Within your employee stock option grant, you will receive an outline of your vesting schedule. Companies have these agreements to provide incentives for employees to stay longer, because a vesting schedule outlines when you receive the option to exercise your stock options.

The vast majority of companies offer a 4-year vesting schedule with a 1-year cliff. What this means is that in a typical vesting schedule, it will take four years of employment for your options to become fully vested and you don't vest anything until one full year of employment. While time-based vesting (where options vest over a set period) is most common, some companies also use milestone-based vesting (tied to specific company achievements) or hybrid schedules that combine both.

The Critical Role of the Vesting Cliff Date

The Vesting Cliff is a critical component of most stock option schedules. It represents the first date on which any of your options become eligible to be exercised. Typically, this "cliff" occurs one year after your grant issue date or vesting calculation date.

For example, in a standard 4-year vesting schedule with a 1-year cliff, 25% of your total options will vest all at once after that first year. The primary reason for a vesting cliff is to incentivize employees to remain with the company, ensuring a commitment period before a significant portion of their equity becomes accessible.

Grade Vesting: How Options Vest Over Time

Once you've reached your cliff date, your options typically continue to vest incrementally, a process known as graded vesting. The most common approach is monthly vesting following the cliff date. For instance, in a standard 4-year plan with a 1-year cliff, you would vest 25% of your options at the one-year mark, and then an additional 1/48th of your total options each month for the next three years. While monthly vesting is prevalent, some equity grants may vest quarterly or even yearly after the initial cliff.

Outlined below is an example of a typical cliff vesting schedule for 20,000 options.

• Grant of 48,000 options on 1/1/2020 with 1-year cliff.
• "The options in this grant will vest as to one forty-eighth (1/48th) of the total number of Shares on the first day of each month following the Vesting Calculation Date."

Essentially, 1/4 aka 12,000 options will vest after the 1-year cliff and 1/48 aka 1,000 options will vest each subsequent month.

Accelerated Vesting

In certain situations, your stock options might vest faster than originally planned, a process called accelerated vesting. This commonly occurs during significant company events, such as a merger or acquisition (M&A). For ISOs, accelerated vesting in an M&A event can sometimes impact the $100,000 ISO limit, potentially causing some options to convert to NSOs.

What happens when my stock options vest?

Once your options vest, you can now exercise them. This doesn't come for free, meaning you must purchase shares at your strike price and often times will owe taxes upon exercise as well. The question then arises of "When should I exercise my stock options", but you have cleared the first hurdle in equity ownership: vesting. The next two hurdles are exercising your options and eventually selling your shares.

Once you vest your shares, you are not required to exercise immediately, but you should be aware of your expiration date. This will be the last date that you can exercise your vested options.

Stock Option Expiration: Your Deadline to Exercise

The expiration date is the final deadline by which you must exercise your vested stock options. After this date, any unexercised options will expire and become worthless.

Typically, stock options have a standard expiration of 10 years from their grant date, provided you remain continuously employed. However, if your employment ends (whether voluntarily or involuntarily), this expiration date will almost always shorten significantly. Additionally, any unvested options or shares will be forfeited once your employment ends.

• For ISOs you will have 90 days to exercise any options you have vested.
• For NSOs your company will dictate the amount of time you are given before expiration.
• RSUs will not expire until your expiration date, however it is possible to convert them into shares of the company, which will have tax implications.
• Public company stock options will typically be cashed out upon leaving the company.

Employees with expiring stock options often face the dilemma of whether or not to exercise. At the end of the day it comes down to 2 main factors:

1. Do you believe in the future of the company?
2. Can you afford to take the risk?

If you don't believe in the future value of the company there isn't any exercise your options just because they exist. You are likely better off investing your hard-earned cash elsewhere. If you do believe in the company and can afford to take the risk, exercise the options! If you cannot afford the risk it may make sense to contact someone like ESO Fund who can cover the cost of exercise and taxes, in exchange for a portion of the future upside.

Tax Considerations for Stock Options

Taxes at Vesting

It's a common misconception that all equity is taxed at vesting. For stock options (both ISOs and NSOs), there is generally no ordinary income tax due at the time of vesting. The primary tax event for stock options typically occurs when you exercise them or when you sell the shares (usually as capital gains).

However, this differs significantly for Restricted Stock Units (RSUs). RSUs are typically taxed as ordinary income when they vest, based on the fair market value of the shares at that time. While many RSUs vest on a time-based schedule, it's common to see double-trigger RSUs in private companies, where vesting is completed only upon both a time-based condition and a liquidity event like a company exit (e.g., IPO or acquisition).

Taxes at Exercise

Unlike vesting, exercising your stock options is often a taxable event. The specific tax implications depend on the type of stock option you hold:

• Non-Qualified Stock Options (NSOs): When you exercise NSOs, the difference between the fair market value (FMV) of the shares on the exercise date and your strike price (often called the "spread") is taxed as ordinary income.
• Incentive Stock Options (ISOs): Exercising ISOs does not trigger ordinary income tax, but the spread may be subject to the Alternative Minimum Tax (AMT). If you hold the shares for the qualified holding periods, you can then qualify for favorable long-term capital gains tax treatment upon their eventual sale. You can estimate your AMT impact using our AMT calculator.

For a detailed breakdown of the tax implications for both ISOs and NSOs, including AMT considerations and capital gains, please see our dedicated page on Stock Option Taxes.

Early Exercise: Buying Options Before They Vest

Can you exercise your stock options before they vest? The answer is yes, but it depends entirely on your company's specific Stock Option Plan and Agreement. Many private companies offer what is known as Early Exercise, which allows employees to purchase their options before the vesting schedule is complete.

The key benefit of early exercise is the potential to lock in a lower Fair Market Value (FMV) for tax purposes, potentially reducing future tax liabilities. However, a critical step if you early exercise is to file an 83(b) election with the IRS within 30 days of exercising. This makes your early exercise official and helps secure potential tax advantages.

It's important to remember that even if you early exercise, the shares you've purchased are still subject to the original vesting schedule. This means that if you leave the company before the shares are fully vested, any unvested shares you early-exercised will typically be repurchased by the company at your original strike price.

ESO Fund strongly recommends checking with your company's HR or equity administrator to confirm whether early exercise is permitted under your plan.

Feel free to reach out to ESO Fund for questions on equity and help funding your option exercise.

Written by Jordan Long, Marketing Lead at ESO Fund