When a group of engineers launched Fairchild Semiconductors—the first chip startup in Silicon Valley—in 1957, investors offered the founders a relatively new type of compensation: stock options.

By the mid-1970’s, investors in venture-funded startups began to give stock options to all their employees. On its surface this was a pretty radical idea. The investors were giving away part of their ownership of the company–not just to the founders, but to all employees.

Why would they do that?

Stock options for all employees of startups served several purposes:

Mechanically, a stock option was a simple idea – an employee received an option (an offer) to buy a part of the company via common stock options (called ISOs or NSOs) at a low price (the “strike price”). If the company was successful, the employee could sell the stock at a much higher price when the company listed its shares on a stock exchange (an “initial public offering”) or was acquired.

...