Option Strike Price

The option strike price is the fixed price per share at which a stock option can be exercised to acquire common stock. It is set at grant date and unchanged for the life of the option, required by IRC Section 409A to equal the fair market value of common stock at grant date (set by the most recent 409A valuation), with significant tax penalties for the recipient if granted below FMV. It is the structural anchor of every option grant and the variable that determines the eventual cash outlay and bargain element at exercise.

The strike-price mechanics:

• Set at grant: the strike price is locked in on the grant date and does not change over the option's life (typically 10 years).
• Equals FMV: Section 409A requires the strike price to equal the fair market value of common stock at grant date. For private companies, FMV is established by a 409A valuation performed by an independent appraiser, typically annually or after material events.
• 409A valuation period: a 409A valuation is generally valid for 12 months or until a material event (new financing, major acquisition, significant business change) that would change FMV. Grants during the valid period use that 409A's price; grants after a material event need an updated 409A.
• The 20-30% common discount: 409A valuations typically price common stock at 20-30% below the most recent preferred price (because common lacks preferred rights). This is why employee strike prices are meaningfully below headline funding-round prices.

The penalty for granting below FMV: Section 409A treats below-FMV options as deferred compensation, triggering immediate ordinary income tax on the holder at vesting (not exercise) plus an additional 20% federal penalty tax plus state penalty tax in some states (California has its own 5% penalty). The economic impact for the recipient is catastrophic: phantom income tax on amounts that aren't yet realized as cash. Why this happens: companies sometimes try to "give a deal" to early employees by setting strike below FMV, or grant on outdated 409As after material events have driven FMV higher. Both create 409A penalty tax exposure that the recipient bears.

The strike price climbing over time: as the company raises rounds and FMV grows, strike prices for new grants climb. Concrete progression example: employee #5 hired at $0.10 strike. Employee #20 hired post-seed at $0.50 strike. Employee #100 hired post-Series A at $2.00 strike. Employee #500 hired post-Series C at $8.00 strike. Each cohort's economic upside depends on the gap between their strike and the eventual exit price.

What founders get wrong: Trying to set strike below FMV to "make it more attractive" or to compensate for low salary. This creates Section 409A penalty tax exposure that the employee bears (not the company), often six-figure tax bills on phantom income with no cash to pay it. The opposite mistake is also common: granting on stale 409As after material events (recent financings, major acquisitions) have moved FMV higher. Either error damages the employee. The right discipline: maintain current 409A valuations, refresh after material events, and never grant below the documented FMV.

Related: Stock Option · 409A Valuation · Option Exercise · Option Grant · Common Stock

FAQ

What is the option strike price?
The fixed price per share at which a stock option can be exercised to acquire common stock. Set at grant date and unchanged for the life of the option (typically 10 years). Required by Section 409A to equal the fair market value of common stock at grant date, set by the most recent 409A valuation.

Why are strike prices lower than the preferred round price?
Because 409A valuations price common stock at typically 20-30% below the most recent preferred price (common lacks the preferred rights). The strike equals common FMV, not preferred FMV, so it's meaningfully lower than the headline round price. This creates the option-holder's bargain element at exercise.

What happens if a company grants options below FMV?
Section 409A treats below-FMV options as deferred compensation, triggering immediate ordinary income tax on the holder at vesting (not exercise) plus a 20% federal penalty tax plus state penalty tax in some states. The economic impact for the recipient is severe; never grant below documented 409A FMV.