Startup companies in California offer stock options to investors and employees as a way of granting these people access to future value. Stocks in startup companies represent privately held shares that lack value in public venues for trading securities. Because the startup has yet to go public with an initial public offering, its stock options differ from stock options issued by public companies. Stock options for a startup company can only produce value once the company goes public or is acquired.
How startups use stock options
A new company has limited resources until it starts generating revenue. A contract for a stock option from a startup promises you a fixed number of shares. You might earn these shares as an employee who trades labor for the stock or as an investor who puts money into the venture.
Both employees and investors accept startup stock options with the hope that the venture will succeed. The company will then create an IPO that allows the public to buy shares. This input of public investment allows the people holding private stock options to cash in at a public stock price that is hopefully high and profitable.
What can go wrong with startup stock options?
The biggest risk comes from the fact that the company might not succeed. The venture fails to generate momentum and never goes public. When that happens, employees and investors never have access to a public market where they can transform their privately held stock into cash or public stocks.
Even if the company shows promise, a decade could pass before it arranges for an IPO. Startups are taking longer to go public than they use to, and the lengthy waiting period could strain the patience and finances of employees and investors.