NSO: Non-Qualified Stock Option

NSO stands for Non-Qualified Stock Option. It’s a way companies, especially startups, can give you (an employee, advisor, or consultant) the option to buy company stock at a set price sometime in the future. Think of it as a coupon for company shares. Unlike its cousin, the Incentive Stock Option (ISO), NSOs offer more flexibility but have slightly different tax implications.

Key characteristics of an NSO:

• Grant Date: The day you receive the options. This date is important for tax purposes and for your vesting schedule (see below).
• Vesting Schedule: NSOs typically vest over time, meaning you gradually earn the right to exercise them. A common vesting schedule is four years with a one-year cliff. This means you can’t exercise any options until you’ve worked for one year. After that, you vest 1/48th of your options each month for the remaining three years. Learn More: Vesting Schedule
• Exercise Price (Strike Price): The pre-set price at which you can buy the shares. This price is usually set at or below the fair market value of the stock on the grant date.
• Expiration Date: The deadline for exercising your options. After this date, they become worthless. Learn More: Grant Date vs Expiration Date Important Timelines
• No Special Tax Treatment at Exercise: Unlike ISOs, exercising NSOs triggers a tax event. You’ll owe ordinary income tax on the difference between the exercise price and the fair market value (FMV) of the stock at the time of exercise. This difference is called the “bargain element.”
• Taxed as Capital Gains Upon Sale: When you eventually sell the shares you purchased through exercising your NSOs, you’ll pay capital gains tax on the difference between the sales price and the FMV at the time of exercise. This is similar to how regular stock sales are taxed.

Example (Illustrative):

Let’s say your company grants you 1,000 NSOs with an exercise price of $1. A year later, you vest and the FMV is $5. If you exercise all your options, you’ll pay ordinary income tax on the bargain element (1,000 shares * ($5-$1) = $4,000). If you later sell those shares for $10 each, you’ll pay capital gains tax on the difference between the sale price ($10) and the FMV at exercise ($5), which totals $5,000.

Why would a company offer NSOs instead of ISOs?

Companies have more flexibility with NSOs. They can be granted to a wider range of people (including advisors and consultants), and there are fewer restrictions. Also, the tax implications for the company can be more favorable.

Why might you consider selling your NSOs before exercising?

There are several reasons why someone might want to sell their vested stock options before they exercise and own the shares. Learn More: Why Sell Shares on the Secondary Market Earlyasset can help you explore the possibility of selling your NSOs pre-IPO and explore the potential for liquidity. Learn More: Instant Offer Getting Indicative Pricing.

So here’s what we covered:

• Definition of NSOs and how they work
• Key characteristics like Grant Date, Vesting Schedule, Exercise Price, and Expiration Date
• Tax implications of exercising and selling shares acquired through NSOs
• Why companies offer NSOs
• Why someone might choose to sell NSOs before exercising