Stock Option Definition
A stock option is a contract granting the holder the right to purchase or sell company shares at a fixed price, called the strike price, on or before an expiration date. Angel investors frequently receive stock options as part of their investment package in early-stage startups.
Why Stock Options Matter for Angel Investors
Stock options provide upside potential without requiring immediate full investment. If a company's valuation increases, options become more valuable. They also align investor interests with company management, as both parties benefit from business growth. Options offer flexibility—investors can exercise them when conditions are favorable or let them expire if the company underperforms.
How Stock Options Work
An option contract specifies:
- Strike price: the predetermined purchase cost per share
- Expiration date: when the option becomes invalid
- Number of shares: how many shares the option covers
- Vesting schedule: when the investor can exercise the option
For example, an angel investor receives options to buy 10,000 shares at $1 per share, expiring in 10 years. If the company grows and shares trade at $5, the investor can exercise the options, purchasing 10,000 shares for $10,000 and immediately owning $50,000 worth of stock.
Call Options vs. Put Options
Call options grant the right to buy shares at the strike price—the typical arrangement for angel investors. Put options grant the right to sell shares at the strike price, less commonly used in startup contexts but valuable for downside protection.
Tax Considerations
Stock options have important tax implications. Incentive stock options (ISOs) may receive favorable tax treatment, while non-qualified stock options (NSOs) are taxed as ordinary income. Investors should consult tax professionals before exercising options.
Related Terms
Learn more about related concepts: Strike Price, Vesting, Equity Compensation, Cap Table, and Exercise.