Meaning
Financial instruments known as stock options require a predetermined purchase price to be set at the time of the grant. The strike price is the amount an individual must pay per share to exercise their option and become an owner. It is typically set at the fair market value of the stock on the day the option is issued.
Exercise Cost
Purchasing the shares requires a substantial cash outlay if the grant size is large. If the strike price is set at ten dollars and the market price is fifty, the holder gains forty dollars of value per share but must still provide the initial ten. This cost can be a barrier for a founder who has most of their wealth tied up in the business.
Tax Calculation
The difference between the market value and the strike price at the time of exercise is often treated as taxable income. A low strike price relative to the eventual exit value maximizes the potential gain but also increases the tax liability. Planning for this payment requires careful management of personal liquidity and sometimes necessitates the sale of a portion of the resulting shares to cover the government’s share.
Options Incentive
Ownership interest only gains value when the market price exceeds the strike price. If the company value falls below this threshold, the options are underwater and provide no incentive to the holder. This situation forces the founder to focus on rebuilding the valuation to regain the lost motivation.
