Grant.
What is a 'Grant'
A grant is the issuance of an award, such as a stock option, to key employees under a stock plan. A stock option grants the employee the right to purchase a certain number of shares of the company's stock at a predetermined price. This price is called the grant price. There is usually a waiting period before an employee can exercise these stock options.
BREAKING DOWN 'Grant'
A grant is offered to employees only after they have worked at the company for a set period of time. Purchasing a stock option is also known as exercising. For more details on stock option grants and tips on determining the best time to exercise, read CNN Money's "Employee stock option plans."
Why Purchase Stock Option Grants?
From the employer's standpoint, the idea behind stock option grants is to give employees the incentive to align their interests with that of the stockholders. In the past, however, some stock option grants have been set at such low levels that executives ended up enriching themselves, not the shareholders.
From the employee's standpoint, a stock option grant is an opportunity to purchase stock in the company he or she works for at a lower price. Typically, the grant price is set as the market price at the time the grant is offered. It is advisable for an employee to purchase a stock option if the market price of the stock goes up in value: the grant price is still the same, so the employee is purchasing a stock at a lower price than market value.
Qualified vs. Non-Qualified Stock Option Grants.
Non-qualified stock option (NSO) grants . They can be transferred to a child or a charity, depending on the specific company's policies. Non-qualified stock option grants are tax deductible by the company that provides them. Since the grant is provided at a specific price, which is usually lower than the market value for the company's stock, employees who choose to take advantage of this opportunity pay income tax on the difference between these two prices upon purchase. It's important to note that employees are not subject to taxes when the option becomes available to them; rather, they only pay taxes when they purchase a stock option.
For a breakdown on exactly what determines a non-qualified stock option and how it is taxed, read Non-Qualified Stock Options .
A qualified stock option grant, also known as an incentive stock option (ISO), is eligible for a special tax treatment: you don't have to pay income tax when you purchase an option, and you instead pay capital gains tax when you sell the option, or taxes on the profits made from the stock option. However, the grant might not be provided at a lower price than market value, as non-qualified options are. Also, this type of grant is riskier, as the employee must hold on to the option for a longer period of time to qualify for this tax treatment. This type of grant is usually reserved for the higher level employees, and the company cannot write off the grant as a tax deduction. ISOs cannot be transferred to another person or entity, unless through a will.
To learn more about how ISOs work and how they are taxed, read Introduction To Incentive Stock Options .
For a guide on both types of stock options and how to handle each, read The Best Strategies to Manage Your Stock Options .
Employee Stock Options Fact Sheet.
What Is a Stock Option?
Stock Options and Employee Ownership.
Practical Considerations.
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Related Publications.
You might be interested in our publications on this topic area; see, for example:
Staying Private: Liquidity Options for Entrepreneurial Companies.
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Equity Alternatives: Restricted Stock, Performance Awards, Phantom Stock, SARs, and More.
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Equity Compensation for Limited Liability Companies (LLCs)
A guide to creating equity compensation arrangements for limited liability companies (LLCs). Includes model plan documents.
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Fast Answers.
Many companies use employee stock options plans to compensate, retain, and attract employees. These plans are contracts between a company and its employees that give employees the right to buy a specific number of the company’s shares at a fixed price within a certain period of time. The fixed price is often called the grant or exercise price. Employees who are granted stock options hope to profit by exercising their options to buy shares at the exercise price when the shares are trading at a price that is higher than the exercise price.
Companies sometimes revalue the price at which the options can be exercised. This may happen, for example, when a company’s stock price has fallen below the original exercise price. Companies revalue the exercise price as a way to retain their employees.
If a dispute arises about whether an employee is entitled to a stock option, the SEC will not intervene. State law, not federal law, covers such disputes.
Unless the offering qualifies for an exemption, companies generally use Form S-8 to register the securities being offered under the plan. On the SEC’s EDGAR database, you can find a company’s Form S-8, describing the plan or how you can obtain information about the plan.
Employee stock options plans should not be confused with the term "ESOPs," or employee stock ownership plans, which are retirement plans.
Employee Stock Option - ESO.
What is an 'Employee Stock Option - ESO'
An employee stock option (ESO) is a stock option granted to specified employees of a company. ESOs offer the options holder the right to buy a certain amount of company shares at a predetermined price for a specific period of time. An employee stock option is slightly different from an exchange-traded option, because it is not traded between investors on an exchange.
BREAKING DOWN 'Employee Stock Option - ESO'
How a Stock Option Agreement Works.
Assume that a manager is granted stock options, and the option agreement allows the manager to purchase 1,000 shares of company stock at a strike price, or exercise price, of $50 per share. 500 shares of the total vest after two years, and the remaining 500 shares vest at the end of three years. Vesting refers to the employee gaining ownership over the options, and vesting motivates the worker to stay with the firm until the options vest.
Examples of Stock Option Exercising.
Using the same example, assume that the stock price increases to $70 after two years, which is above the exercise price for the stock options. The manager can exercise by purchasing the 500 shares that are vested at $50, and selling those shares at the market price of $70. The transaction generates a $20 per share gain, or $10,000 in total. The firm retains an experienced manager for two additional years, and the employee profits from the stock option exercise. If, instead, the stock price is not above the $50 exercise price, the manager does not exercise the stock options. Since the employee owns the options for 500 shares after two years, the manager may be able to leave the firm and retain the stock options until the options expire. This arrangement gives the manager the opportunity to profit from a stock price increase down the road.
Factoring in Company Expenses.
ESOs are often granted without any cash outlay requirement from the employee. If the exercise price is $50 per share and the market price is $70, for example, the company may simply pay the employee the difference between the two prices multiplied by the number of stock option shares. If 500 shares are vested, the amount paid to the employee is ($20 X 500 shares), or $10,000. This eliminates that need for the worker to purchase the shares before the stock is sold, and this structure makes the options more valuable. ESOs are an expense to the employer, and the cost of issuing the stock options is posted to the company's income statement.
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