Stock options and stock warrants are both commonly granted by private companies and play a valuable role in attracting employees, advisors, and investors as the startup grows. While similar, warrants and options come with their own advantages and disadvantages, and it’s important for founders to understand the differences before issuing either.
The basics of stock options and stock warrants
Stock options are a type of equity compensation that give employees the right to buy company shares at a set price (the strike price) after a vesting period. There are two main types of stock options used by private companies: incentive stock options (ISO), which can have tax advantages, and non-qualified stock options (NSO), which can be more flexible, but are taxed as regular income.
Stock warrants are an agreement between two parties that gives one party the right to buy the other party’s stock at a set price, over a specified period of time. Once a warrant holder exercises their warrant, they get shares of stock in the issuing party’s company.
Warrants vs. stock options: Key differences
| Stock Warrants | Stock Options | |
| Issuer | Issued by the company directly to investors or lenders. | Issued by the company typically to employees as compensation. |
| Purpose | Used to attract investors or lenders by offering future equity. | Used to incentivize and retain employees by offering potential ownership. |
| Exercise price | Typically set when issued and can be negotiated. Often equal to the price of the recent Preferred Stock Transaction, a discount to the PST price, or at $0.01. | Set when granted, often based on fair market value. |
| Underlying shares | Newly issued shares when exercised. Can be for Common or Preferred Stock. | Typically existing company shares from an employee equity pool. Only for Common Stock. |
| Expiration period | Usually longer-term (5-10 years). | Typically shorter-term, with a vesting period. |
| Trading | Can sometimes be traded separately. | Not tradable; meant for employees. |
| Dilution impact | Causes dilution as new shares are issued upon exercise. | Often causes dilution depending on company structure. |
| Settlement | Often settled in cash or shares. | Settled in shares upon exercise. |
| Tax implications | Taxed as capital gains when exercised and sold. | Tax treatment varies; ISOs can have tax advantages, while NSOs are taxed as ordinary income upon exercise. |
Should I choose stock options or stock warrants?
The right type of equity for your startup depends on the recipient. Stock options can maximize employee retention, while warrants can hold investor interest.
When to choose stock options
If your goal is to attract and retain top talent, offering stock options like ISOs or NSOs can help align their interests with the company’s long-term success. Some stock option plans can also offer tax advantages for employees.
When to choose warrants
If you're fundraising or need to incentivize strategic advisors or board members, issuing warrants can be a flexible way to offer equity without immediate dilution to your equity pool. Warrant recipients can often benefit from longer expiration periods and potential capital gains tax benefits.
Give your employees a clearer view of equity ownership
Equity Advisory, an addition to Carta’s cap table, provides your employees with personalized equity-based tax support. Click below to learn more.
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