DGCL Sec. 157 - Rights and Options

By now, stock options have become well known as a device for employee compensation in corporations.  A stock option provides the holder with the right to purchase a share of the corporation at a stated price.  When this "strike price" is below the price of the shares trading in the stock market, the options are considered "in the money" and the optionholder has an economic incentive to exercise the stock option. When the strike price is above the market price for the stock, such options are considered "out of the money" since the optionholder does not have an incentive to exercise the options.

Because stock options increase in value with an increase in the stock price, options are thought to be reasonably efficient incentive mechanisms in cash poor start-up ventures, delivering value to employees when the firm succeeds. This is especially true when employees can see a direct link between their work and the success of the venture. For many employees at start-up firms, the prospect of equity-based compensation with a big upside if the firm is successful is attractive. 

In addition, stock options can be helpful in bonding employees to the start-up company in another way. Stock options "vest" over time. That is to say, once granted, an employee cannot immediately exercise all of their options. The optionholder will only be able to exercise the options after they vest. Vesting periods are typically tied to annual employment anniversaries. If an employee leaves the start-up before the options vest, then the employee loses the options altogether. Vested options typically have to be exercised within 6 months of leaving the firm. The effect of vesting and option expiration to make leaving the firm expensive for employees, thus bonding employees to the start-up venture.