Strike Price
The fixed price at which an employee can purchase shares of company stock under a stock option agreement, set at the time the option is granted.
What Is a Strike Price?
The strike price — also called the exercise price or grant price — is the predetermined price per share that an option holder must pay to convert their stock options into actual shares of company stock. This price is locked in at the time the option is granted and does not change regardless of what happens to the company's valuation afterward. If the company grows and its share price increases, the gap between the strike price and the current fair market value represents the option holder's unrealized gain.
In private company equity compensation, the strike price is typically set at the fair market value of the company's common stock on the grant date, as determined by a 409A valuation. This ensures the options are granted "at the money" and comply with IRS Section 409A requirements.
How Strike Price Works
Setting the Strike Price
When a company grants stock options, it must determine the fair market value of its common stock. For private companies, this requires an independent 409A valuation — a formal appraisal conducted by a third-party valuation firm. The valuation examines the company's financials, comparable public companies, recent funding rounds, and other factors to arrive at a per-share value for common stock.
The strike price is set at or above this 409A valuation price. Setting it below fair market value would create an immediate taxable event under Section 409A and could result in a 20% penalty tax plus interest for the employee — a situation both companies and employees want to avoid.
Strike Price vs. Current Value
The relationship between the strike price and the current fair market value determines whether options are "in the money," "at the money," or "out of the money":
- In the money: Current FMV is higher than the strike price. The options have intrinsic value.
- At the money: Current FMV equals the strike price. This is the typical state at the time of grant.
- Out of the money (or "underwater"): Current FMV has fallen below the strike price. Exercising would mean paying more than the shares are currently worth.
The Bargain Element
When you exercise options that are in the money, the difference between the current FMV and your strike price is called the bargain element (or spread). This amount has significant tax implications — it determines your ordinary income recognition for NSOs and your AMT adjustment for ISOs.
Practical Implications for Startup Employees
Why a Low Strike Price Matters
Early employees at startups often benefit from a lower strike price because the company's 409A valuation is typically lower in its early stages. As the company grows and raises additional funding rounds, subsequent 409A valuations generally increase, meaning later employees receive options with higher strike prices.
A lower strike price means a lower total cost to exercise your options and a larger potential gain if the company succeeds. It also means a smaller upfront cash outlay when you decide to exercise, making early exercise strategies more accessible.
Strike Price and Exercise Costs
Your total exercise cost is calculated as: strike price × number of shares. If you have 10,000 options at a $0.50 strike price, exercising all of them costs $5,000. If a later employee has 10,000 options at a $5.00 strike price, their exercise cost is $50,000. This tenfold difference in out-of-pocket cost significantly affects exercise timing decisions and financing needs.
When the Strike Price Resets
In some situations, a company may reprice its options — lowering the strike price on existing grants to match a new, lower 409A valuation after a down round. Repricing is relatively rare because it has accounting and tax consequences, but it does happen when a company's valuation drops significantly and existing options are deeply underwater.
How It Relates to Exercising Stock Options
The strike price is the foundation of every exercise decision. It determines how much cash you need, what your tax exposure will be, and whether exercising makes financial sense at all. Before exercising, compare your strike price to the current 409A valuation to understand the spread — this is the number that drives your AMT calculation for ISOs and your ordinary income for NSOs. If you are considering financing your exercise, the strike price determines the loan amount you will need to cover the purchase of your shares.