Exercise Price and Selling Price
- Exercise price is the price an employee pays to exercise his or her stock option and purchase a share of the company.
- Selling price is the price an employee receives when they sell their shares.
- The difference between the selling price and the exercise price is the profit made by the employee.
Recap: Stock Options
Stock options grant holders the right, but not an obligation, to purchase shares in the company. The shares can be purchased at a predetermined price within a specified time period. This is known as the exercise price or strike price.
Stock options are used as an employee benefit known as employee stock option plan (ESOP).
The exercise price is the price you pay to exercise your stock option and buy one company share under an ESOP. If employees decide to exercise their vested stock options and purchase shares, they will pay the exercise price to do so.
Exercise price can be determined in three different ways. 1) Last round valuation, 2) Discounted last round valuation, and 3) Low Fixed Price.
First, using the last round valuation means that the exercise price of each stock option is simply the share price at the last funding round. The price of each share is thus determined by investors in that round.
Second, using a discounted last round valuation means that the exercise price of each stock option is a discounted price from the last round valuation. For example, a company wants to issue stock options with an exercise price at a 40% discount of the last round valuation. Assuming the share price of the last round is $1 per share, the exercise price would then be $0.60 (40% discount off $1).
The last way to determine the exercise price is to set it to a low price. This makes it economical for stock options holders to exercise their stock options and maximizes the financial benefits of the ESOP. We tend to recommend that companies go with this option.
There is often confusion about exercise price and selling price. The selling price refers to the amount that employees receive when they sell their shares.
The selling price is usually determined during a liquidity event such as a fundraising round or an exit. Based on the price per share during that round, shareholders can choose to sell their shares (at the selling price) and receive the amount based on the selling price and the number of shares sold.
In summary, ESOP holders will have to pay the exercise price to exercise their stock options and purchase shares. They will now own an equivalent number of shares based on how many stock options were exercised. In the event of a liquidity event, they can sell their shares at the selling price.
If you’d like to know more about ESOP, our 5-min guide can help!
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Disclaimer: All contents in the article are based on our own opinions and interpretations, and the reader agrees to discharge us of any liabilities for any error or omissions. Article is not meant to be legal or tax advice, but for informational purpose only.