What does equity mean for me in practical terms in a job offer?

Question

I am looking at a job offer and they are offering me the following equity package:

Equity: 14,000 stock options
Equity Breakdown: All equity goes on a 4 year vesting schedule, with a
1 year cliff. The numbers below show what the equity was most recently
evaluated at (IMPORTANT!!!! Your numbers are subject to change because
they are set and based on when you start with the company and if our
board sets a new price.)
Most recent strike price for employees: $2.60
Most recent value per share: $ 12.75
Value per share: $10.15
$10.15 x 14,000 = $142,100 in Grant Day Value

So in practical terms, what does this mean? It sounds like in one year I get the option to purchase at a very low price 1/4 of 14,000 shares. Can I somehow put this in my 401k? Or do I just use this like regular stocks and hang onto it until I feel it's the right time to sell? Is there anything else special about this sort of thing?

Nuclear Hoagie · Accepted Answer

Stock options represent the option to purchase a share of stock in the future at some specified price, which is called the "strike price". This price will be set when your options are granted, although you will have to wait until the options actually vest until you can exercise them (exercising an option means buying a share at the strike price). The strike price is often set as the market value on the day of the grant, although here it seems the strike price is set by the board explicitly. If the board sets the strike price below the market value, options have immediate value.
The strike price may or may not be a "very low price" depending on what the stock does in the future. If the stock price remains above the strike price, you retain the option to buy the stock at the lower strike price - this is great, since you can buy at the strike price and sell at the market price for an immediate profit. If the market price goes below the strike price, you are left with the option to buy the stock at higher than market price, which one would never do in practice - if the stock price falls below your strike price, you'd be better off buying a share from the open market rather than exercising the option.
The package example shows a rather lucrative stock option, where the market price is higher than the strike price - in the example, you are able to exercise an option to buy a share that's currently worth $12.75 for the low price of $2.60. This does not necessarily mean that your equity package will be worth a similar amount - if the stock price falls below the strike price, a grant of stock options is worth absolutely nothing. Compensation in the form of stock options gives the benefit of large potential gains, but they are risky in that they may ultimately be worth nothing. Having a board-set strike price that's below the market price at grant reduces the risk somewhat, since the options will be worth something the day they're granted, and will continue to have value even if the stock price doesn't move at all.
After options vest, you'll have some period of time (perhaps 10 years, check your plan specifics) in which you can exercise them to buy stock at the strike price. You can immediately sell that stock to earn the profit over the strike price (the $10.15 per share in the example), or you can hold onto the stock like you would any other share, and sell it at a later date to enjoy a lower, long-term capital gains tax (but then you risk the stock falling below what you paid for it).

D Stanley · Answer

So in practical terms, what does this mean?

It means that part of your compensation will be in the form of stock options, or the option to buy stock on a fixed date at a fixed (strike) price. That stock gives you a (small) percentage of ownership in the company, that you can sell if the company goes public (if it's not already public).

It sounds like in one year I get the option to purchase at a very low price 1/4 of 14,000 shares.

The strike price is fixed, so as long as the value of those shares is more than $2.60 then yes, you'll be able to buy shares at a discount. If the value of the stock goes below $2.60 then your stock options are worthless (why would you buy stock at $2.60 when you could buy it for less?)

Can I somehow put this in my 401k?

Not directly, since you can only contribute to a 401(k) through salary deferral. But you could sell the stock once it vests and adjust how much you contribute to your 401(k) accordingly.

What does equity mean for me in practical terms in a job offer?

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