Stock options are one of the most powerful tools a startup has, both financially and culturally. They sit at the intersection of three interests: employee, employer, and investor.
For startups, option grants serve several purposes at once. They allow the company to reward employees even when cash is tight and salaries can’t compete with those of larger companies. They also build engagement and motivation by turning employees into genuine partners in the company’s success. When the company reaches a liquidity event such as an exit (IPO or M&A) or a secondary deal, employees share in that success.
From an investor’s perspective, a healthy option pool is a sign of a healthy company. It means the company can continue attracting and retaining top talent for key positions and reward them in a way that aligns with long-term growth.
In this chapter, we’ll cover the basic concepts every founder and early employee should understand about stock options, and share practical rules of thumb for allocation: how much is typically granted, to whom, and what factors to consider when building or updating your option plan.
Let’s start with the key terms every founder and employee should know when it comes to employee stock options.
What Employee Stock Options Really Mean?
An employee stock option is the right to purchase a share of the company at a predetermined price, known as the exercise price (or strike price).
When employees receive options, they are not yet shareholders. They only hold the right to become shareholders in the future, by exercising those options.
Exercise Price (Strike Price): The exercise price is the amount an employee must pay to convert an option into an actual share.
It’s important to note:
- In early-stage Israeli startups, it is common to set a very low exercise price. Sometimes as low as one cent or even one Agora to make the process accessible and straightforward.
- In the United States, there are tax regulations that require the exercise price to reflect the fair market value (FMV) of the share at the time the option is granted.
- As a result, the same company may have employees in different countries holding options with different exercise prices. U.S.-based employees typically have a higher exercise price compared to employees in Israel.
What Is a Vesting Period?
Employee stock options are not available for immediate exercise. They vest over time according to the company’s option plan and the employee’s agreement.
Cliff: The cliff is the initial period, typically the first year, during which no options vest.
At the end of this period, the employee usually becomes entitled to 25% of their total grant at once.
Ongoing Vesting: After the cliff, the remaining options continue to vest gradually, either monthly or quarterly, until the employee reaches full vesting, usually after four years.
This structure helps the company retain key employees and rewards those who stay and contribute to its long-term success.
What Types of Shares and Investor Rights Exist?
Startups typically issue two main types of shares, each with different rights and purposes.
Ordinary Shares
These are the shares usually granted to founders and employees.
They do not include any special privileges or protections.
Preferred Shares
These are the shares allocated to investors.
They come with additional rights designed to protect investors’ capital and influence key company decisions. Common examples include:
- Liquidation preference: Investors get their money back before anyone else in an exit or liquidation event.
- Choice between return and share value: Investors can choose whichever outcome is higher.
- Additional rights such as voting power, veto rights, and participation in future funding rounds.
As the company matures and attracts more investors, the gap between ordinary and preferred shares often narrows, reflecting the company’s growing stability and negotiating power.
How Many Stock Options Do Companies Usually Grant to Employees?
Investors expect startups to maintain an option pool reserved for employees, typically around 8-12% of the company’s shares at the Seed stage.
This pool is meant to cover new hires and retention grants until the next funding round (Series A).
At the Series A stage, if only a few options remain, investors usually ask to expand the pool, and this expansion typically comes at the expense of existing shareholders.
This is considered a shared interest, because both founders and investors want the company to have enough equity to attract and retain strong talent.
Is 5,000 Options a Lot?
The absolute number of options is not what matters. What counts is the:
- The FMV of the company and the PPS (Price Per Share) at the time of the grant gives a sense of the value of the shares.
- Percentage of ownership they represent.
For example, 10,000 options might equal 1% of the company at an early stage, but later become 0.5% as the company raises more capital and grows.
Even though the percentage decreases over time, the value of the company and of those options usually increases, meaning the options can still become more valuable over time.
Typical Ranges and Timing Considerations:
- For non-executive employees, it is common to grant around 0.1%–0.2% of the company.
- For executive team members, grants usually range between 0.5%–1.2%, depending on the person’s experience and the impact their role is expected to have on the company’s value.
For example, there is a clear difference between a first-time VP of Business Development and a seasoned VP whose track record directly influences company valuation.
Timing matters. As a startup evolves, its needs shift and so does the value generated by different functions at each stage. Naturally, the functions driving the most impact tend to be rewarded accordingly.
In the early stages, R&D leadership is central to shaping and building the core product. As the company scales and the product matures, the center of gravity often shifts toward business, sales, and finance leadership, as go-to-market and operational execution become more critical.
When hiring employees in functions that are especially important at a given stage may receive larger option grants, reflecting the strategic weight of that hire and the impact expected from the role at that point in time.
What Is Fair Market Value (FMV or 409A) and How Is the Exercise Price Determined?
Every option grant must have a defined exercise price, this is the price employees pay if they choose to purchase their shares.
To make sure this price is fair and compliant, companies determine it based on the fair market value (FMV) of the company’s shares at the time the options are granted.
The FMV, often referred to as a 409A valuation, is an independent assessment of a private company’s share price in the U.S.
It is usually conducted by specialized firms such as Altshuler, Scube, and others, and is typically based on the company’s most recent funding round, adjusted to reflect the value of ordinary shares, those granted to employees.
Because ordinary shares lack the special rights of preferred shares held by investors, they are generally valued lower.
As the company grows and its valuation increases, it can no longer grant new options with a symbolic or near-zero exercise price. Typically, each new funding round increases the company’s valuation, and with it, the exercise price of new option grants.
In other words, the higher the company’s valuation, the higher the price per share.
For example, a company valued at $300 million would grant new employees options priced according to the current fair market value at that time.
Even so, employees still benefit from the future appreciation of the company’s shares — which is where the real upside of stock options lies.
What Happens to Share Value When the Company Raises a New Funding Round?
When a company raises money from investors, its overall valuation increases, but the ownership percentage of existing shareholders decreases. This is called dilution.
Example:
A company raises 4 million dollars at a 10 million dollar pre-money valuation.
After the round, the company’s post-money valuation becomes 14 million dollars.
The new investors now own around 30% of the company, and all existing shareholders, including founders and employees, are diluted accordingly.
For employees, dilution means that the number of shares they own stays the same, but their percentage of ownership becomes smaller. However, if the company’s overall value grows, the monetary value of their options can still increase over time.
While dilution reduces each shareholder’s ownership percentage, it usually reflects a positive step forward for the company, assuming the new capital helps drive meaningful growth.
What Happens When the Company Raises a SAFE?
A SAFE (Simple Agreement for Future Equity) is a way for startups to raise money without setting a valuation immediately.
The company receives the funds now, but the actual share allocation happens in the next equity round.
In return, investors receive either a discount (typically around 20%) or a valuation cap, which serves as the maximum valuation used to calculate their future shares.
SAFE rounds are often used when a company needs additional capital but does not want to raise a full equity round at a low valuation.
This approach helps extend the company’s runway, allowing it to continue operating and growing before bringing in the next major investor who will set the new terms.
From an employee perspective, a SAFE round does not immediately affect existing option holders, since no new shares are issued yet. However, once the SAFE converts in the next funding round, the resulting shares contribute to dilution, just like any other investment.
Disclaimer: This playbook is provided for general informational purposes only and does not constitute legal advice or create an attorney-client relationship. Employment laws vary by jurisdiction, and founders should consult a qualified employment attorney before acting on any hiring, termination, or other HR decisions discussed here.