Stock Options for a Private Company: What You Need to Know

If you’ve ever worked at a startup or are considering a role at a private company, chances are you’ve heard about stock options. They’re one of the most attractive incentives for employees—but also one of the least understood.

In this guide, we’ll break down exactly what stock options for a private company are, how they work, and what you should consider before accepting them.

What Are Stock Options for a Private Company?

Stock options give employees the right to purchase shares of the company’s stock at a fixed price (called the exercise price or strike price) after a certain period.

This is not the same as owning stock outright—you gain the option to buy shares in the future, typically after a vesting period.

How Do Private Company Stock Options Work?

Here’s how the process usually plays out:

Grant – You’re offered a specific number of stock options as part of your compensation package.
Vesting – You earn the right to exercise options over time (e.g., 25% per year over four years).
Exercise – After vesting, you can buy the stock at the predetermined price.
Exit – You can sell your stock during a liquidity event (IPO, acquisition, or secondary sale).

Since the company is private, you usually can’t sell your shares freely until the business goes public or is acquired.

Why Do Private Companies Offer Stock Options?

Private companies often use stock options to:

Attract top talent without paying high salaries
Align employee incentives with company success
Encourage long-term commitment through vesting schedules
Build a sense of ownership and culture

It’s a win-win if the company grows: employees share in that upside.

Types of Private Company Stock Options

There are two main types:

Incentive Stock Options (ISOs)

Only available to employees
May qualify for special tax treatment
Must meet certain IRS rules

Non-Qualified Stock Options (NSOs)

Can be offered to contractors, advisors, and employees
Do not qualify for ISO tax advantages
Easier to administer but potentially higher tax implications

Key Terms to Understand

Term	Meaning
Vesting	Timeline for earning stock options
Cliff	Period before first vesting kicks in (e.g., 1 year)
Strike Price	The set price to buy shares
Fair Market Value (FMV)	Estimated value of the company’s stock
Liquidity Event	Event that allows stockholders to sell shares

Risks & Considerations

While stock options can be lucrative, there are risks:

No guarantee of liquidity: Shares may remain unsellable for years.
Stock may be worthless: If the company fails, the options become meaningless.
Exercising costs money: You might need to pay out of pocket before any gain.
Leaving the company? You may have a limited window to exercise your vested options.

Always read the stock option agreement carefully and consider getting legal or financial advice.

Real-World Example

Let’s say you receive 10,000 options at a strike price of $1/share. Years later, the company goes public, and shares are worth $10 each. If you’ve exercised your options, your stake could be worth:

10,000 x ($10 – $1) = $90,000 gain

But remember, you’ll need to pay taxes and exercise costs depending on your situation.

Conclusion

Stock options from a private company can be an exciting and potentially lucrative part of your compensation—especially if the company succeeds. But it’s crucial to understand how they work, what your rights are, and what the exit options look like.

Do your homework, ask the right questions, and consider working with a financial advisor to make the most of your equity.