It seems like just yesterday that your employer gave you options to buy 1,000 shares of company stock at $10 a share. Today, the market price jumped to $15 a share. You're itching to exercise the options, buy the shares and flip the stock for a quick $5,000 profit. But not so fast. If your options are like most incentive stock options, you're going to have to wait, fingers crossed, until the big "vesting date."
Employee Stock Options
All kinds of companies give their employees stock options as incentives. An employee stock option gives you the opportunity to buy shares of your employer's stock at a predetermined "strike price." If the strike price is lower than the market price of the stock at the time you can exercise the option, then you stand to make a nice profit. The aim of the stock option is to align your interests with those of your company's shareholders — namely, you all want the stock to go up.
When you get an incentive stock option, you typically can't use it right away. It wouldn't be much of an "incentive," after all, if your profit came baked right in and you could enjoy it immediately. You usually have to stay with the company a certain length of time to become eligible to exercise your options. The date when options truly become "yours" to exercise is the vesting date.
Stock options "vest" according to a vesting schedule, and companies can set the schedules to reflect the kind of incentive they're trying to give. For example, a company could give you options on 6,000 shares that vest all at once in five years, which would be designed to keep you around for the long haul. Or you could get staggered options that reward you in stages, with, say, 100 options a month for five years. The company may let you exercise options immediately after each batch "vests," or only in stages, or you may not be able to exercise them until you either get fully vested or you leave the company.
One common vesting technique goes by the name of "the cliff." This requires a specific period of time before any options vest at all. For example, you may have to work for a full year or two years before vesting begins, after which your options begin to vest on a regular schedule. The cliff serves several purposes, such as maintaining a strong incentive and preventing take-the-money-and-run situations soon after the options are granted. For start-ups that give new hires options — not an uncommon practice — the cliff can protect the company from the possibility of a bad hire racking up vested stock options that the company would then have to let him exercise right before the employee is terminated.
Cam Merritt is a writer and editor specializing in business, personal finance and home design. He has contributed to USA Today, The Des Moines Register and Better Homes and Gardens"publications. Merritt has a journalism degree from Drake University and is pursuing an MBA from the University of Iowa.