Glossary of Terms

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$100K Rule

A tax rule for incentive stock options (ISOs) that limits the amount of ISOs that can qualify for tax benefits in any calendar year. If the value of ISOs that first vest in a year exceeds $100,000, the excess value must be treated, and taxed, as an NSO. Most equity comp software (e.g. Carta) automatically analyzes for the $100k rule and will split equity grants into ISO and NSO grants accordingly, but not always.

409a Valuation

A 409a valuation is an independent appraisal of the fair market value ("FMV") of a private company's common stock. Because the valuation of a private company could be subjective, the IRS provides guidance on key things to consider + acceptable methods of determining valuation (in section 409a of the Internal Revenue Code (IRC); hence the name "409a valuation"). Amongst other use cases, the 409a valuation is used to set the exercise price of stock options and determine taxation and withholding requirements (if any) when stock options are exercised.

10b5-1 Plan

A 10b5-1 plan is a written trading plan that allows employees of a publicly traded company to sell or purchase stock in their own company without facing potential accusations of trading on insider information (including during blackout periods). 10b5-1 plans are SEC-approved, and require the individual to stipulate the timing, pricing, and amounts of trades to be made (typically many months or years in advance). These future trading rules/plans are made when the individual does not possess material nonpublic information, providing an affirmative defense against illegal insider trading claims.

83(b) Election

A tax election you can make with the IRS to recognize compensation income from the exercise of stock options or restricted stock prior to when its vests (most frequently 83(b) elections are made when a grant is issued). By making an 83(b) election, you accelerate your tax liability (if any) based on the prevailing pricing at the time of the election, enabling all future appreciation in the stock to be taxed as capital gains rates (vs. ordinary income). This occurs when you early exercise an option.

A

Accelerated Vesting

Accelerated vesting is a provision in a company's equity plan or individual equity grant that stipulates that unvested shares will automatically and fully vest should certain circumstances or events occur, such as the employee being terminated. The two most common acceleration clauses are known as (i) "single trigger" (options vest upon a change in control) and (i) "double trigger" (options vest upon a change in control and employment is terminated due to the change in control).

Alternative Minimum Tax (AMT)

The Alternative Minimum Tax (AMT) is a parallel tax system to federal income taxes that is/was designed to ensure that high-income taxpayers pay at least a minimum amount of tax. The AMT is calculated by adding back certain deductions and exemptions that are allowed for regular income tax purposes, and then applying a different tax rate.

AMT Credits

AMT credits are tax credits that can potentially be used to offset regular income tax liability. AMT credits are available to taxpayers who have paid AMT in previous years. The amount of the AMT credit is based on the amount of AMT that was paid in previous years. See here for more information on recouping your AMT credit

AMT Crossover

The AMT crossover is a calculation that projects the maximum number of ISOs that can be exercised and held in a given year without incurring AMT.

Automatic Enrollment (ESPP)

Some companies have automatic enrollment into the firm's ESPP program. If yours does, every employee is automatically enrolled to contribute a certain percentage of their paycheck towards the purchase of company stock (typically at a discount). Employees usually have the option to opt out or change their contribution rate if they want to.

B

Bargain Element

The bargain element is the intrinsic value or "spread" between the exercise price of a stock option and the fair market value (FMV) of the stock at exercise. The bargain element represents a gain that the option holder would receive if they exercise their options. For example, if a stock option has a strike price of $1.00 and the FMV of the company is $3.00, the bargain element is $2.00 per share.

Blackout Period

For publicly traded companies, a blackout period is a timeframe during which company insiders and employees are restricted from buying or selling company stock. These blackout periods are typically enacted around significant corporate events like earnings announcements to prevent illegal insider trading when executives may have access to market-moving non-public information.

Blackout periods help protect companies and insiders by limiting ability to trade equities while financial results that have not been disclosed publicly remain confidential. Most commonly, publicly traded companies have blackout periods that start 0 to 15 days prior to the end of a fiscal quarter, and end 2-4 days after the company reports their fiscal quarter results.

C

Capital Gains

The profit incurred when selling an investment asset for a higher price than the purchase price. Capital gains are categorized as either short-term or long-term based on the holding period of the asset.

Capital Losses

The loss incurred when selling an investment asset for a lower price than the purchase price. Capital losses are categorized as either short-term or long-term based on the holding period of the asset, and can be used to offset capital gains (i) in the current tax year or (ii) carried forward to offset capital gains in future years.

Cashless Exercise

A transaction in which an individual that has a stock option (with value/a positive bargain element) for a publicly traded company, (i) exercises the option, and (ii) receives the after tax value of the bargain element, (iii) without needing to provide any cash up front.

In practice, a broker (e.g. Schwab) is providing the option owner with a temporary loan. The loan proceeds are used to exercise the option (with the broker paying the company both (i) the purchase price per share and (ii) required withholding taxes), and the broker immediately sells the shares on the open market. 2-3 days later when the trade settles, the sale proceeds are used to repay the loan, and the remaining cash is given to the exercising/selling individual.

Clawback Provision

A contractual clause in an equity-based compensation arrangement that allows a company to recover incentive pay like bonuses or stock options from employees if certain conditions are not met.

Cliff

In a vesting schedule, a cliff is a period of time (most commonly one year) before any vesting begins. Once the cliff period ends, employees receive all accrued vesting at once in a lump sum. After that, vesting continues according to the regular schedule.

Concentration Risk

The risk of loss associated with having a large portion of one's investments concentrated in a single asset, stock, or market segment. For employees, concentration risk often refers to having a significant amount of one's wealth concentrated in the stock of their employer. If the employer's stock declines substantially in value, it can have a devastating impact on the employee's net worth and financial well-being. If you want/need help developing a plan for concentration risk, see Divestment/Sale Planning

Constructive Sale (IRS Definition)

When trading in derivatives, the IRS has a rule known as a "constructive sale." It largely states that if you own an appreciated financial position like stock or a bond and enter into certain derivatives transactions, you can be taxed as if you sold the underlying asset even though you still own it if the contract substantially diminishes your risk of loss in the underlying position. The rule was enacted to prevent taxpayers from using derivatives to lock in gains on assets without realizing a taxable event.

D

Dilution

A reduction in the ownership percentage of a company's shareholders due to the issuance of additional stock. New stock might be issued in a public offering, private placement, acquisition, equity raise, or employee equity compensation plan. Dilution means each share now makes up a smaller portion of total shares outstanding.

Discount (Employee Stock Purchase Plan)

Employee stock purchase plans (ESPPs) may offer shares at a discounted purchase price (most commonly 5-15%).

Disqualified ISO Disposition

The sale of shares acquired via exercising an ISO before both of the ISO qualifying disposition criteria are met (i.e. the ISO must be granted at least 2 years prior to sale of the stock, and the ISO must be exercised at least 1 year prior to the sale of the stock). Disqualified ISO dispositions have different (typically inferior) taxation as compared to qualifying ISO dispositions.

Diversification

The strategy of allocating investments across various assets, sectors, industries, and securities to reduce risk. A diversified portfolio most commonly has a mix of investment types and asset classes, has exposure to both domestic and and international assets, includes large and small companies, and considers the correlation across different asset classes.

Dividend

A distribution of company profits paid out to shareholders. Dividends provide a way for shareholders to earn income from stocks in addition to potential stock price appreciation.

Double Trigger Restricted Stock Units (RSUs)

RSUs that require two events to occur, usually a vesting event and liquidity event like an IPO, before the shares formally vest (and thus are delivered and taxed). This avoids employees incurring taxes on non-liquid RSUs as they time-vest, but with no ability to sell shares to cover the taxes.

Downside Risk

The possibility of loss due to a decline in the value of an investment.

E

Early Exercising

Exercising a stock option prior to the option vesting according to the vesting schedule. Early exercise is allowed only if permitted under the terms of the option agreement. Every early exercise includes an 83(b) election.

Employee Stock Purchase Plan (ESPP)

An ESPP is a program commonly offered by public companies that allow eligible employees to purchase company stock, often at a discount. ESPPs can provide a way for employees to gain equity in their company, usually with unique benefits (discounts and lookbacks). For more information see: Employee Stock Purchase Plan (ESPP)

Equity

Equity is a percentage ownership in a company, representing a claim on the earnings, profits, and assets of the company after all debts are satisfied. Equity ownership is conveyed via shares of stock, and owners of stock are known as shareholders. A company can issue as many shares of stock as it likes, and each share of stock represents a fraction of ownership of the business (typically a very, very small fraction). When a company issues stock, it is selling partial ownership in the company to investors. Stockholders share in its success or failure based on the stock price and any dividends they receive.

Exercise Date

The date a stock option is exercised (wherein the owner of the stock option purchases the underlying shares of company stock). Typically, a stock option can be exercised on any date the option holder chooses prior to the expiration of the grant (provided the options have vested according to the vesting schedule, or the option grant allows for early exercise).

Exercise Price (aka Strike Price)

The specified price at which an option holder has the right to purchase a specified number of shares in the company. The exercise price is stated in the option agreement.

Expiration Date

The date after which any unexercised options will expire and no longer be exercisable.

F

Fair Market Value (FMV)

The value a company is deemed to be worth, which is used to set the exercise price of stock options and determine taxation and withholding requirements (if any) when stock options are exercised. A pre-IPO company will almost always have and use a 409(a) valuation to determine their FMV, while a publicly traded company's FMV will be its stock price.

FICA Tax (aka Payroll taxes)

FICA stands for Federal Insurance Contributions Act, and is the tax that funds Social Security and Medicare benefits. Paid by both employers and employees, the Social Security portion funds retirement and disability benefits, up to a wage maximum. The Medicare portion funds health insurance for elderly Americans, with no wage maximum. Employees pay FICA taxes through automatic withholding in their paychecks.

Forfeit Value

The monetary value of unvested stock awards or options that an employee loses due to events such as termination, resignation, or not meeting performance requirements.

Forfeiture Risk

The potential loss of unvested stock awards or options by an employee due to events such as termination, resignation, or failure to meet performance requirements.

G

Grant Date

The date your company officially gives or allocates equity compensation like stock options, restricted stock, or RSUs to you.

H

Holding Period

The amount of time you hold an asset, such as stock options, restricted stock, or other shares. Many forms of equity compensation have required holding periods before you can buy, sell, and/or receive preferential tax benefits.

I

Illiquid

An asset that is difficult (or impossible) to convert into cash quickly without incurring significant loss of value. Illiquid assets cannot be readily bought or sold due to lack of willing buyers, non-existent markets or exchanges, and/or restrictions on sales.

Incentive Stock Option (ISO)

A type of stock option issued by companies that provides tax benefits to employees if certain requirements are met. For more information see: ISO Stock Option

Initial Public Offering (IPO)

When a private company first lists its shares on a public stock exchange like the Nasdaq or New York Stock Exchange. This process transitions the company from being privately owned to being publicly traded. During the IPO process, companies and/or existing shareholders sell shares. For the company, these sold shares allow it to raise money from new shareholders to fund its growth. For employees and other existing shareholders, selling allows them to realize value from their company ownership.

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L

Liquidation

The process of selling off a company's assets to pay off its debts and liabilities, typically as part of a bankruptcy proceeding or the winding down of operations. Liquidations aim to maximize the recovery value of assets to settle as many financial obligations as possible, either to restructure the business or dissolve the company.

Liquidity Event

A transactional event that allows (at least some) shareholders of a company to sell some of their shares. Most commonly this is a company acquisition, an Initial Public Offering, or a tender offer. For more information see: Liquidity Event Planning

Liquidation Preference

When VCs invest in a company, their investment may includes a requirement known as a liquidation preference. There are multiple types, but in general, it specifies that the investor has a right to be paid back (typically their initial investment amount, though it can be higher) before other shareholders receive any distribution proceeds (e.g. from the sale of the company via acquisition).

Lock-Up Period

A temporary restriction on selling shares of a company's stock after an initial public offering (IPO). A lock-up prohibits insiders like founders, executives, employees and early investors from selling any shares during the lock-up period (which are most commonly 6 months in length). The intent of a lock-up period is to help stabilize the stock price as the company transitions to public trading.

Lookback Provision

A clause in an employee stock purchase plan (ESPP) that allows employees to buy company stock at the lower of (i) the price at the beginning of the offering period and (ii) the price at the end of the offering period.

Long-Term Capital Gains

The profit from selling an investment asset that has been held for over one year. Long-term capital gains are taxed at lower rates than short-term gains and ordinary income. For more information see: Capital Gains & NIIT

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N

Non-Qualified Stock Option (NSO)

NSOs grant employees the right to purchase company stock at a fixed price for a specified period of time. Although the option gives the employee the choice to buy stock, it does not obligate them to do so. The ability to purchase shares usually becomes available over time through a vesting schedule. As employees vest in more of their grant, they earn the right to buy a greater portion of the shares (usually monthly or quarterly). For more information see: NSO Stock Option

Net Settlement

If a Pre-IPO company allows it, net settlement is a way for employees to exercise stock options in a private company without paying cash. Instead of using cash to purchase exercised shares, a portion of the options are withheld to cover the cost.

For example, if an employee has 100 options at a $1 strike price, and the FMV is $4, they would normally need to pay $100 to exercise all the shares, and each share (at least on paper) would have $3 of value. With net settlement, they instead could (i) exercise 75 shares, and (i) "pay" for the exercise of those shares by forfeiting the remaining 25 shares (each of which has $3 of value; 25 * 3 = $75).

O

Option Pool

A number of shares set aside by a company to grant stock options and other equity incentives to employees, executives, and board members. An option pool provides equity to attract and retain key talent while aligning their interests with shareholders.

Option Leverage

Option leverage refers to the fact that stock options like ISOs and NSOs have leverage implicitly built into them (due to the way they work). The larger the bargain element value is, the less implicit leverage the option has, and vice versa. For example, an individual has vested options with a $10 strike price, and the company is currently trading at $11 per share:

• At the current point in time, the exercise of the options (excluding taxes) would provide the individual with $1 per share in value.

• If the value of the company increases by $1 per share, that represents a +9.1% change in the stock price ($11 -> $12), but a 100% increase in the value per share of the option ($1 -> $2)

Ordinary Income Tax

The personal income tax levied by the IRS on most types of income. For more information see: Federal Income Tax

P

Performance-Based Vesting Schedule

An equity compensation vesting schedule where options vest upon achieving certain performance milestones, rather than just based on time. Performance milestones are usually tied to key company metrics like revenue, profits, or stock price.

Performance Hurdle

Equity compensation grants with performance-based vesting schedules must include a performance hurdle; a trigger that must be met in order for the option to vest.

Phantom Stock

Phantom stock is a type of incentive compensation that provides employees with benefits similar to equity ownership, but without granting them actual equity in the company. Phantom stock is relatively rare in the high-growth/VC-backed startup world, but the most frequent use case is for privately owned companies that don't want to issue equity or dilute corporate ownership but still want to incentivize employees to grow the value of the company. For more information see: Phantom Stock

Post-Termination-Exercise-Period (PTEP)

A PTEP is the amount of time after you leave a company (voluntarily or involuntarily) that you have to exercise your vested stock options. The most common period is typically 90 days, but a large number of companies offer PTEPs that extend this considerably longer (e.g. 1 year, 3 years 10 years). PTEPs can typically be provided in two ways: (1) A firm-wide policy that applies to all employees and their stock option grants, or (2) grant-specific, meaning that different stock option grants can (and likely will) have different PTEPs associated with them.

Preclearance Individual

And individual at a publicly traded company who the company believes will frequently have material non-public information. The company will designate these individuals at "preclearance", meaning at even outside of blackout periods, they need to get internal approval prior to selling shares. Due to these limitations, preclearance individuals very frequently setup 10b5-1 plans to facilitate the legal selling of their shares for personal financial planning and diversification purposes.

Preferred Stock

A class of corporate equity security that holds certain privileges over common stock; most specifically, a priority claims on dividends and assets in a liquidation.

Pre-IPO

The period before a private company completes its initial public offering (IPO) and first lists shares on a public stock exchange. When a company is pre-IPO, its stock is privately held rather than publicly traded. For Pre-IPO companies, equity compensation is generally illiquid, and may also be difficult to value.

Purchase Date

The date when shares are actually bought on behalf of employees participating in an employee stock purchase plan (ESPP). Employee contributions made during the prior purchase period are used to purchase company stock on the purchase date.

Purchase Period

The period of time, often 6 months, leading up to a purchase date in an employee stock purchase plan (ESPP). During the purchase period, participating employees contribute after-tax money from their paychecks that is reserved to buy company stock at the end of the period. The amount of stock purchased depends on the contributions made and any discount or lookback provisions in the plan.

Q

Qualified ISO Disposition

The sale of incentive stock option (ISO) shares at least two years after the grant date and one year after the exercise date.

Qualified Small Business Stock (QSBS)

Special rules under Section 1202 of the federal tax code allow individuals to exclude some or all of the capital gains from the sale of QSBS from taxation. For shares to qualify as QSBS, very specific criteria around the company, investors, and how shares are issued and held must be met. For more information see: Qualified Small Business Stock Exclusion

R

Restricted Stock Award (RSA)

Shares of company stock granted to an employee with restrictions on sale or transfer for a specified period of time. The employee can vote and receive dividends on the shares, but cannot sell or transfer the shares until the restrictions lapse. Once restrictions lapse, the shares can be sold or transferred and are taxed as compensation income. RSAs provide employees equity ownership and incentive, as the value depends on company stock price performance over the restricted period. For more information see: Restricted Stock Award (RSA)

Restricted Stock Unit (RSU)

A form of equity compensation where company shares are granted to an employee, but with restrictions that must be met before the shares can be sold or transferred. RSUs vest over time or when performance goals are achieved. Once vested, the shares are issued and taxed. RSUs provide employees equity exposure and long-term incentives, with the potential for significant value if the company stock price appreciates over the vesting period. For more information see: Restricted Stock Units (RSUs)

Risk Tolerance

The degree of uncertainty or potential financial loss an investor is able and willing to accept in pursuit of higher targeted returns.

S

Safe Harbor

Safe Harbor can have multiple meanings with regards to stock comp and taxes. Generally, it means that one followed tax rules by taking reasonable steps regarding some data point. For more specific situations:

• In regards to a 409a valuation, when a company has the valuation conducted by an independent third party (with the knowledge to do it), it establishes a safe harbor -- meaning that the IRS should presume it was “reasonable”.

• In regards individual tax payments and withholdings, the IRS has certain "safe harbor" rules regarding how much withholding and estimated tax payments you should pay in during the tax year to avoid underpayment penalties. For more details, see this H&R Block article

Seed Stage

The earliest (or near earliest) phase of startup development where the business concept is validated, core features are built, and initial funding is secured to cover basic operating costs. Seed stage companies have a vision for addressing a problem or need in the market, but require seed funding to finance product development and potentially validate their business/product concept.

Short-Term Capital Gains

The profit from selling an investment asset that has been held for one year or less. For more information see: Capital Gains & NIIT Tax

Staggered Vesting Schedule

An equity compensation vesting schedule where portions of the grant vest over time, rather than all at once. This helps provide ongoing incentive and retention effects over the vesting period.

Stock Appreciation Rights (SARs)

A form of equity compensation that gives the right to benefit from the increase in company stock price. SARs vest over time and, once vested, provide compensation equal to the stock price appreciation. SARs incentivize employees to increase company stock price over the vesting period. For more information see: Stock Appreciation Rights (SAR)

Stock Options

Contracts issued by companies that give employees the right, but not the obligation, to purchase company stock at a fixed price for a period of time. Stock options provide a way for employees to share in the potential growth and success of the company.

Strike Price

See Exercise Price

T

TIE Rule

The TIE Rule is term coined by 30-40 Wealth; focusing on the amount of (1) Time, (2) Interest, and (3) Expertise you have in doing your own financial planning. For technology professionals, if you can check all 3 boxes of the TIE rule, then you're probably in good shape to create your own financial plan and manage your finances. But if you're missing one or more of the boxes, you'll likely derive higher value by partnering with an advisor who specializes in the unique planning needs of technology professionals (freeing up time for you to focus on higher-value-add work activities, family, or other things that bring you joy).

Tender Offer

Tender offers are made by a company or investor to buy a large number of shares of a company. For technology workers, tender offers most typically apply to private/Pre-IPO companies and generally occur in tandem with a VC capital raise. The offers allow shareholders an opportunity to sell some (or potentially all) of their stock. For more information see: Tender Offers & Secondary Market Sales

U

Underwater Stock Options

A stock option is said to be "underwater" when the strike price of an option is higher than the current market value. For example, a stock option with a strike price of $10 per share, and the company is currently trading at $8 per share would have no value (strike of $10 > current value of $8), and said to be "underwater".

Unvested

Refers to equity compensation like stock options, restricted stock or RSUs that an employee or executive has been granted but does not yet own outright. Unvested equity is subject to forfeiture or buyback if the employee leaves the company before meeting specified vesting conditions like a particular date or performance milestone.

V

Vesting

The process of earning the rights to your equity compensation (like stock options, restricted stock, or RSUs) over time according to a vesting schedule. Vesting aims to align employee and shareholder interests by requiring you to stay with the company to "earn into" ownership of your shares or grant.

Vesting Schedule

The timetable established by a company under which employees gain full ownership of equity compensation grants like stock options, restricted stock, or RSUs over a defined period. For more information see: Vesting Schedules

W

Withholding

The portion of your income from salary, and other sources of compensation taxed as income (e.g. RSUs or exercising NSO stock options), that your employer deducts and remits to the IRS and state tax authorities on your behalf to cover the estimated amount of taxes you will owe.

Wash Sale

A wash sale occurs when an investor sells or trades a security at a loss and then repurchases the same or substantially identical security within 30 days. The IRS has a rule against this, created to discourage investors from selling specifically to harvest tax losses and then buying back shares shortly after (effectively being able to claim the loss for tax purposes while effectively keeping the same position). Wash sale rules should be considered when tax loss harvesting or making other strategic tax trades involving losses, as well as in regards to various stock-based-compensation transactions such as exercising options and ESPP plan purchases.

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