An Employee Stock Option Plan is a slice of equity compensation that lets employees cash in on the company's growth. Startups and other fast-growing firms dish out these options to push employees to pump up share values. Not only does this save the company cash, but stock option plans have also been proven to improve productivity, increase employee satisfaction, and generate better value for the company in the long-term compared to just cash compensation. They also ensure that employees are locked in for certain time periods, reducing employee turnover.

Instead of handing over shares directly under an employee stock option plan, employers give derivative options, letting employees snag stock at a locked price for a set time under an equity incentive plan. When share prices jump past the exercise price, employees can buy at a discount, allowing them to take advantage of the business’ growth.

There are two types of stock options available.

Incentive Stock Options (ISOs): These gems are reserved for the top brass, offering company shares at a discount with a tax break bonus. Hold onto them for at least two years, and you're looking at lower taxes on profits thanks to long-term capital gains rates.

Non-Qualified Stock Options (NSOs): Not just for employees, but also investors and partners, NSOs don't come with the tax perks. Any gains get taxed as ordinary income, plain and simple.

Once established, the employee stock option plan serves as template for issuing equity to employees. Combined with a cap table management software (at Apex, we like to use Carta), managing equity becomes a breeze.