Employee stock options: What are they and how do you value startup stock options?

What are employee stock options?

While stocks are actual equity shares, i.e., ownership stakes, stock options give you the choice to purchase company stock in the future at a predetermined price. Note that while publicly traded stocks also have options contracts, those financial instruments differ from employee stock options. Options contracts involve speculating on the future price of a stock, whereas employee stock options are a type of equity compensation, generally meant to reward employees based on their tenure and the company's performance.

Unlike some other types of equity compensation like restricted stock units (RSUs), however, stock options do not inherently turn into actual shares. Instead, employees have the option to pay to exercise their options, which then converts the options into shares. This cost is based on the strike price, also known as the exercise price. The strike price is generally set at or above the fair market value of the startup at the time you're granted the stock options, due to tax rules.¹

Then, once you've held the options long enough to satisfy the vesting period, you have the right to exercise the stock options at the strike price. A common vesting period at startups is four years, although employees typically vest a portion of their total option grants along the way, e.g., 25% per year. However, vesting schedules and exercise terms can vary by company and individual grant. As options vest, they are exercisable along the way, rather than having to wait until your full option grant becomes 100% vested.

For simplicity's sake, suppose an individual has 100 vested stock options with a $10 strike price. That means the individual could exercise those startup stock options for $1,000 and would receive 100 shares of the company's stock.

Ideally, the strike price is below the market value at the time of exercise. After four years, for example, the startup may have completed multiple funding rounds. In that case, 100 shares of the company could be worth $10,000 if the most recent funding round valued the shares at $100 each. Before accounting for taxes, this means they'd gain $9,000 in equity value by exercising ($10,000 stock value vs. $1,000 exercise cost).

There is no obligation to make the purchase. If the startup's valuation has gone down below the strike price valuation, for example, they might not want to exercise the stock options.

What are the different types of stock options?

There are two main types of employee stock options: incentive stock options (ISOs) and nonstatutory or non-qualified stock options (NSOs).

ISOs: ISOs are often considered to be the more tax-friendly type of stock option, as you might not have to pay income tax on them until you ultimately sell the stock. Still, exercising ISOs may trigger the alternative minimum tax (AMT), so it's important to check with a tax professional to see how stock options affect your financial situation.

Also, ISOs tend to have more restrictions, such as only being granted to employees, not advisors. They also typically can't be transferred during the recipient's lifetime.²

NSOs: NSOs generally provide more flexibility than ISOs, such as your employer potentially letting you transfer these stock options to other people. Also, you might have a longer post-termination exercise period with NSOs than ISOs (though your employer might still allow ISOs to convert to NSOs if they want to give former employees more time to decide whether to exercise).

The downside, however, is that NSOs are often taxed earlier than ISOs. That happens either when you're granted the options or when exercising, depending on if you can readily determine the fair market value at the time of the stock option grant.³

How to value startup stock options

Valuing stock options in startups isn't always straightforward, as private market pricing data isn't as transparent and readily available as it is for publicly traded stocks.

However, you might be able to get some sense of what startup stock options are worth, such as when reviewing equity compensation offers or when weighing whether to exercise your stock options.

One way to do so is to see what trading activity looks like on a private marketplace such as Forge. Shares for that specific startup might already be changing hands on the marketplace, or you might see what trading activity looks like for similar companies. The latter might be used as a guidepost to inform expectations about future valuations for your startup, though there's no guarantee that your company will follow the same path.

Similarly, you might look at recent valuations following funding rounds. If a venture capital fund acquires startup equity at a higher valuation than what your strike price is based on, for example, then you might be encouraged to exercise the options, receive company shares and potentially sell that stock at some point for a profit.⁴

Also, current employees — and potentially even prospective hires — could ask HR or their leadership team for the latest 409A valuation data. Private companies need to get these independent valuations as part of IRS requirements for issuing equity or stock options, and many startups do so at least every 12 months to fall under IRS safe harbor rules. While startups aren't obligated to share this information with employees, they might be willing to do so to help you understand the value of your stock options.

How to exercise startup stock options

Exercising your stock options means purchasing shares at your strike price. When you exercise, you transition from holding the right to buy stock to actually owning equity in the company. Deciding when to exercise depends on your financial situation, the company's trajectory and your tax strategy.

Taxes play a significant role in this decision. For ISOs, exercising does not inherently trigger ordinary income tax, but it may expose you to the AMT. For NSOs, the difference between your strike price and the fair market value at the time of exercise is generally taxed as ordinary income.³ Because the tax implications of exercising stock options vary based on an individual's circumstances, individuals should consult a qualified tax advisor before making a decision.

Another critical factor is what happens if you leave the company. Most startups enforce a post-termination exercise window, often 90 days, during which you must exercise your vested options or forfeit them.⁵ This dynamic can create a difficult decision for employees who want to depart but face a high cost to exercise or an uncertain tax outcome.

After exercising, you hold actual shares in a private company, but those shares are typically illiquid. Shareholders may need to wait for a liquidity event such as an IPO, or explore selling shares through a private marketplace like Forge, subject to transfer restrictions and demand from eligible buyers.

Challenges of exercising stock options

Some employees do not have the liquidity to pay the exercise cost, or they don't understand how stock options work so they leave their options unexercised.

A 2025 Schwab study found that about two-thirds of stock plan participants have not exercised or sold their equity awards — 40% of these participants are waiting to become fully vested, while almost half are waiting for more favorable market conditions, and 29% are worried about the tax implications.⁶

However, there are solutions to these types of issues. In terms of coming up with the money to pay the exercise cost, employees might consider possibilities such as company loans or recourse loans from private lenders that may enable you to exercise options if the valuation makes sense. Also, consider speaking with your HR team or a financial advisor to help evaluate how to manage your stock options. Schwab found that participants who work with an advisor are more likely to understand how to exercise and sell their equity, assess the equity's value, and understand associated taxes.⁶

Turning your startup stock options into opportunity 

If you're thinking about exercising your options, or have already done so, and are looking for a path to potential liquidity, Forge's marketplace provides access to private market transactions. Create an account to explore available opportunities to sell your equity, subject to eligibility and market demand.