Employee Stock Options (ESOs) are a prevalent form of equity compensation in startups, designed to align employee interests with company growth. They grant employees the right to purchase company shares at a predetermined price, known as the exercise price or strike price, after a specified period or upon meeting certain conditions. This mechanism allows employees to benefit financially as the company's value increases.​

Key Components of ESOs

1. Grant Date: The date on which the company awards the stock options to the employee.​
2. Vesting Schedule: A timeline that dictates when employees can exercise their stock options. A common structure, which is the structure of the AugMend Health plan, is a 4-year vesting schedule with a 1-year cliff, meaning:
   • 1-Year Cliff: No options vest during the first year.​
   • Monthly Vesting Thereafter: After the first year, options vest monthly over the next three years.​
3. Exercise Price (Strike Price): The fixed price at which employees can purchase each share, set by the Board of Directors on the grant date.
4. Expiration Date: The last date by which employees must exercise their options before they expire, commonly 10 years from the grant date or a set period after employment termination, which is how the AugMend Health plan is set up.
5. Exercise (Purchasing Shares): The act of buying shares at the strike price. Post-exercise, employees can hold or sell the shares, depending on company policies and market conditions.​

Types of Stock Options

1. AugMend Health has set up and offers for employees Incentive Stock Options (ISOs): Offered exclusively to employees, ISOs may qualify for favorable tax treatment under the U.S. Internal Revenue Code if specific holding periods are met.
2. AugMend Health has set up and offers for Advisors (and possibly others) Non-Qualified Stock Options (NSOs or NQSOs): These can be granted to Advisory Board members, directors, contractors, and others. NSOs do not qualify for special tax treatments, and are taxed as ordinary income upon exercise.

Example Scenario

• Option Grant: An employee is granted 10,000 stock options at a strike price of $.50 per share.
• Vesting: Following a 4-year schedule with a 1-year cliff:​
  • After 1 Year: 25% (2,500 options) vest.​
  • Monthly Thereafter: Approximately 208 options vest monthly over the next 36 months.​
• Exercise: If the market value rises to $15 per share after four years:​
  • Profit per Share: $15 (market price) - $.50 (strike price) = $14.50.
  • Total Profit: 10,000 options × $14.50 = $145,000 (before taxes).

Tax Implications

Tax treatment varies based on the type of stock option and holding period:​