Employee stock options are a great way to attract and retain top talent, especially for startups and growing companies with limited cash flow. Since managing capital is critical, many small businesses turn to options like the SBA's microloan program which provides loans up to $50,000, making non-cash incentives particularly valuable. Employees often feel incentivized to help the business do well when they know they'll share in the company's future financial success. Additionally, employers can offer more competitive compensation packages without committing to higher salaries.
Not sure if this type of employee benefit is right for your company? Let's explore how employee stock options work so you can decide.
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What is an employee stock option?
An employee stock option gives workers the right to buy company shares at a predetermined price, called the strike price. Think of it as a future opportunity—your employee can purchase shares later at today's price, potentially profiting if the company's value grows.
Several factors influence stock value: industry trends, market conditions, and company performance. When the business performs well, stock value typically increases, allowing employees to buy low and sell high.
Here's what makes employee stock options unique:
- No immediate ownership: Employees get the right to buy shares, not actual shares
- Strike price advantage: The purchase price is typically set below market value
- Vesting requirements: Employees must earn the right to exercise over time through a vesting period
- Choice factor: Unlike stock grants which are part of total compensation, employees can choose whether to purchase
How do employee stock options work?
Imagine your company grants an employee 1,000 stock options at a strike price of $5 per share. The employee exercises that option and spends $5,000 on shares. Then, the market price hits $25 per share, and they have $25,000 in stock.
Now, say the employee sells their $25,000 in company stock. After subtracting the $5,000 they put in, they've earned a $20,000 profit. That figure represents the employee's capital gains—the profit earned from selling stock (or any other asset) for more money than the purchase price.
Here's where vesting becomes crucial. Employees typically can't exercise their options immediately—they earn the right over time, which keeps talent engaged and committed to your company's long-term success.
For employers, this commitment is one of the most attractive elements of employee stock options. Here are two more reasons you might consider giving your workers the chance to buy shares:
- Cost-effective compensation: Offering employee stock options is a cost-effective way to create a competitive compensation package without spending as much money upfront.
- Tax benefits: You might get tax deductions for the expense of granting stock options to employees, which would offset some of the costs of an equity compensation plan.
There is one potential drawback: Issuing new shares of stock to employees dilutes the ownership of the existing shareholders. However, many organizations—especially startups and growth-stage companies—feel the tradeoff is worth making because it allows them to pay less for better talent.
Pros and Cons of Employee Stock Options
Thinking about offering stock options? Let's break down what you're getting into—both the wins and the challenges:
Pros of offering ESOs
- Attract and retain top talent: In a competitive market, equity can be a powerful differentiator—especially when you're competing against larger companies with deeper pockets. Stock options help level the playing field.
- Align employee and company goals: When employees have skin in the game, they think like owners. Their personal success becomes directly tied to the company's growth and profitability.
- Conserve cash flow: For startups and high-growth companies, offering equity allows you to create competitive compensation packages without draining limited cash reserves. This leaves more capital for product development and growth initiatives, which can be significant undertakings; for context, some SBA loan programs for small businesses have a maximum loan amount of $5.5 million.
- Tax advantages for the company: Depending on your jurisdiction, you may receive tax deductions when employees exercise their options, helping offset some program costs.
Cons of offering ESOs
- Ownership dilution: Every option granted is a potential future share that dilutes existing ownership. You'll need to balance the value new talent brings against the equity you're giving up.
- Administrative complexity: Managing a stock option plan requires ongoing legal and financial administration, including 409A valuations, cap table management, and compliance tracking.
- Communication challenges: Stock options can be complex to explain, especially to employees unfamiliar with equity compensation. If the value isn't clear, the benefit loses its impact.
- Potential morale issues: If your stock price doesn't perform as expected, underwater options can become a source of frustration rather than motivation.
Types of employee stock options
Stock options aren't one-size-fits-all. Here are your main options:
- Incentive stock options (ISOs): Tax-advantaged for U.S. employees, allowing deferred taxes until shares are sold. May trigger alternative minimum tax.
- Non-qualified stock options (NSOs): More flexible, available to anyone regardless of location, but with immediate tax implications upon exercise.
- Restricted stock options (RSOs): Granted gradually over time with selling restrictions until vesting period ends.
- Employee stock purchase plans (ESPPs): Allow discounted stock purchases through payroll deductions with specific offering periods.
- Performance shares: Tied to specific company goals like revenue targets or profitability milestones.
- Phantom stock: Cash payouts based on stock value without actual ownership, using virtual stock option plans to simulate equity compensation.
Tax implications of offering stock options to global employees
Got a global team? You're not alone—but offering stock options internationally gets complicated fast. Here are the main challenges:
Adhering to tax laws and local regulations
Tax treatment of stock options depends on the worker's home country. For example, the tax code in the U.S. is different from that of France, so an employee in France would need to research their specific tax implications.
Depending on the country, employers may have tax withholding requirements. Failure to adhere to such requirements can result in costly penalties.
Creating an international employee stock ownership plan
You can use an international employee stock ownership plan (ESOP) to grant equity in your business to employees. The structure will vary based on your company's location and the type of stock options you wish to grant, making creating an ESOP tricky.
Choosing the right equity incentive
To choose the best equity compensation plan for your company, you'll need to weigh the pros and cons of each type for you and your employees. For example, ISOs are tax-advantaged for U.S. employees but don't offer the same benefits to workers in other countries. NSOs are more universally applicable but may come with different tax implications depending on the employee's location.
It's not an easy path to navigate, but partnering with an expert like Oyster can help.
Employee Stock Options vs. Other Equity Compensation
While ESOs are a popular choice, they're not the only way to offer equity compensation. Understanding the alternatives helps you choose the right incentive structure for your team and situation.
Stock options vs. restricted stock units (RSUs)
Unlike options, RSUs are a promise to grant employees shares at a future date, with no purchase required. They always have some value as long as the stock price is above zero, making them less risky for employees. However, RSUs typically offer less potential upside compared to options since there's no strike price discount. RSUs also trigger immediate tax obligations upon vesting, while options allow employees to control the timing of taxable events.
Stock options vs. stock appreciation rights (SARs)
SARs give employees the right to the monetary equivalent of the increase in stock value over a set period. No stock is actually purchased—the employee receives a cash payment. This simplifies administration and avoids dilution, but it doesn't create the same sense of ownership as actual equity. SARs also require the company to have cash available for payouts.
Stock options vs. phantom stock
Phantom stock tracks company value without granting actual ownership. Like SARs, it pays out in cash based on stock performance. This works well for companies that want to preserve equity for founders and investors while still incentivizing employees. However, phantom stock can create cash flow challenges and doesn't provide the same psychological ownership benefits.
Which equity compensation is right for you?
Which option fits your situation?
- Stock options: Best for early-stage companies with high growth potential and limited cash
- RSUs: Ideal for mature companies with stable stock prices
- Cash-based alternatives: Perfect when you want to limit dilution while still sharing value
How to Create an Employee Stock Option Plan
Here are some of the steps you'll need to take to offer stock options to your employees:
- Adopt or create an employee stock option plan.
- Get a 409A valuation to determine the fair market value of your company stock (crucial for tax purposes).
- Set a strike price that aligns with the fair market value of your shares.
- Decide on a vesting schedule.
- Determine how long employees have to exercise their options after they leave the company.
Beyond these basic steps, you'll also need to consider:
- Board approval: Your board of directors must approve the plan and any option grants.
- Legal documentation: Work with legal counsel to draft option agreements and plan documents that comply with securities laws.
- Communication strategy: Develop clear materials to help employees understand the value and mechanics of their options.
- Ongoing administration: Set up systems to track grants, vesting, exercises, and compliance requirements.
Managing Stock Options for Global Teams
Offering stock options to a distributed team introduces layers of complexity that can catch even experienced People leaders off guard. What works seamlessly in the United States can trigger compliance nightmares in other countries. Here's what you're up against:
The regulatory maze
Every country has its own securities laws, and many require specific filings or approvals before you can grant options to local employees. Just as certain U.S. government business programs define an eligible rural area by population, each international jurisdiction has unique criteria and regulations for equity compensation. In some jurisdictions, you may need to register your plan with local authorities or provide translated documents. Miss these requirements, and you could face penalties or have your grants invalidated.
Tax withholding challenges
Employer obligations for tax withholding vary dramatically between countries. In some locations, you're required to withhold taxes at the time of grant. In others, it's at vesting or exercise. Get it wrong, and you're not just facing penalties—you're also creating a terrible employee experience when someone gets hit with an unexpected tax bill.
Cultural and communication barriers
Explaining stock options is hard enough in your home market. Now imagine doing it across different languages, currencies, and levels of familiarity with equity compensation. In some countries, employees may never have encountered stock options before. Without careful communication, your generous equity package could be met with confusion or skepticism.
Making global equity work
Here's the bottom line: you need both smart technology and human expertise. Systems handle the compliance calculations, but local experts navigate market nuances. A global employment partner bridges this gap—designing compliant plans and ensuring your international team actually understands their equity value.
Key Takeaways on Employee Stock Options
Employee stock options remain one of the most powerful tools for building committed, motivated teams—especially when cash is limited but growth potential is high. Done right, they align everyone's interests and create real wealth-building opportunities for your employees.
Remember these critical points:
- ESOs work best when employees understand their value—invest in clear communication
- The type of option you choose has significant tax implications for both you and your employees
- Global teams add complexity that requires expert guidance and robust systems
- Success depends on proper setup, ongoing administration, and strategic planning
Employee stock options are a valuable employee benefit, but incorporating stocks into your workers' total rewards is hard to do without expert help. Oyster's equity compensation assessment tool simplifies the process of determining the fair market value of your shares. It helps you develop a plan that meets your needs—and the needs of your employees.
Book a demo today to see how Oyster can help you hire, pay, and manage global talent in over 180 countries.
About Oyster
Oyster is a global employment platform designed to enable visionary HR leaders to find, engage, pay, manage, develop, and take care of a thriving distributed workforce. Oyster lets growing companies give valued international team members the experience they deserve, without the usual headaches and expense.
Oyster enables hiring anywhere in the world—with reliable, compliant payroll, and great local benefits and perks.
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