Employee stock options are how an early startup competes for engineers against companies that can simply pay more. An option is the right to buy shares later at a price fixed today — so if the company's value rises the holder buys cheap, and if it does not the option is simply never exercised and nothing was risked. In the United States that right comes in two flavors, incentive stock options (ISOs) and non-qualified stock options (NSOs), and it is earned over time through vesting rather than granted outright. Both founders granting options and candidates evaluating them need to understand the mechanics, because vague promises here cause real damage later.

This article is educational only. Equity compensation sits at the intersection of securities law, tax law, and valuation — Projects House is an engineering firm, not a law or accounting firm. Any option plan should be set up with a startup attorney and a CPA.

How the Mechanism Works

The grant fixes a strike price — the price at which the holder can buy a share in the future. It is normally set at fair market value on the grant date, which for a private company means a defensible valuation rather than a number someone picked. The holder's gain is whatever the shares are eventually worth above that strike.

The right is not immediate. It accrues through vesting, and the conventional structure is four years with a one-year cliff: leave before the first anniversary and you get nothing, then vest monthly or quarterly for the remaining term. The logic mirrors founder-share vesting described in our article on the founders agreement.

ISOs vs NSOs

  • ISOs can only go to employees, come with statutory limits, and can receive favorable capital-gains treatment if holding-period requirements are met — but exercising them can create alternative minimum tax exposure, which catches people off guard.
  • NSOs can go to employees, contractors, and advisors. The spread between strike and value at exercise is taxed as ordinary income, with withholding.

Two other terms decide whether options are worth anything in practice. The exercise window after leaving — often short — determines whether a departing employee can afford to buy the shares they earned. And early exercise provisions change the tax timeline substantially. Neither should be an afterthought.

The Option Pool

A company reserves a block of shares up front for grants — commonly somewhere between a tenth and a fifth of the company. Two things founders learn the hard way:

  • The pool is usually created before an investment round, because investors want its dilution to come out of the founders' side rather than theirs. Pool size is therefore part of deal negotiation, not an administrative detail — see the term sheet explained and equity dilution explained.
  • The pool has to cover the whole hiring plan. Over-granting to the first three hires leaves nothing for the next ten, and expanding the pool later dilutes everyone again. Model it against the roles you actually intend to fill.

All of this belongs on a maintained capitalization table rather than in a founder's memory — see what a cap table is.

How Much Does an Employee Get

There is no formula, but the principle is consistent: the earlier the hire and the greater the risk taken, the larger the share. A senior first engineer might receive a low single-digit percentage; the thirtieth employee, a small fraction of one percent.

What matters more than the raw option count is the context. A grant of "50,000 options" means nothing without knowing the fully diluted share count. Anyone evaluating an offer should ask three questions: what percentage of the fully diluted company is this, what is the strike price and the current fair market value, and what happens to the options if I leave or if the company is acquired. A founder who will not answer those is telling you something.

What Options Do Not Do

Options are not a substitute for a livable salary. Someone who cannot cover rent will not stay years on a promise. They are also not glue for a weak team — they reward shared success but do not create it.

Above all, their value rests on trust. A founder who obstructs exercise, changes terms retroactively, or refuses to explain the numbers burns reputation in a small hiring market where engineers talk to each other. That is not a recoverable asset. And loose verbal promises of "a few percent" with no plan behind them are exactly the kind of undocumented obligation that surfaces awkwardly in investor due diligence.

Communicate the Value Honestly

Options only motivate when the recipient understands them, and most recipients do not. Have a real conversation with every grantee: percentage of the company, strike price, what happens on departure and on acquisition, and worked numeric scenarios — including the scenario where the equity is worth zero. That candor builds trust and protects you from a later claim of having been misled. Two complementary practices are worth adopting: refresh grants, because a long-tenured employee whose options have fully vested has lost the retention incentive, and a fair post-termination exercise window, because a window too short to fund makes the whole grant theoretical for anyone who leaves.

The Wider Ownership Picture

Options are one layer of a company's ownership structure, alongside founder shares and investor preferred stock. The complete picture and how each round changes it are covered in pre-money vs post-money valuation and splitting equity between co-founders. For the broader context of building a hardware company, see our startup hub and how to start a hardware startup.

Equity is how you pay for engineering you cannot yet afford in cash — but not every discipline needs to be a full-time hire. If you would rather buy specific engineering capability for a defined scope than grant equity for it, tell us what you are building through our contact form.