Derivatives

1. What Are Derivatives — and How Do They Relate to Private Equity?

A derivative is a financial instrument whose value is based on (or “derived” from) something else – usually an asset, like stocks, interest rates or company value

Examples of common derivatives include:

2. Futures or forwards
3. Warrants
4. Swaps

In the context of employee equity, the most relevant derivative is the stock option.

2. What does this have to do with Private Equity?

In a private company (like a startup or unlisted business), your stock options are not linked to a publicly traded stock price. Instead, their value is based on:

• The company’s internal valuation
• Any external funding rounds (Seed, Series A, Series B, etc.)
• The company’s performance over time

Private equity firms (PE firms) often invest in these companies — and they care deeply about growth, performance, and future profitability. If your company has PE investors, they may:

• Influence when the company exits (via IPO or sale)
• Push for performance milestones
• Control the timing of liquidity events (when you can sell shares)

As an employee, this means:

• The value of your derivative (stock option) is closely tied to the decisions and outcomes driven by private equity investors
• Your upside is often aligned with theirs — if the company performs well and is sold or listed, both PE investors and employees with stock options benefit

This is all explained in simple terms. While we don’t expect you to understand every technical detail, having a basic understanding of how derivatives work can help you make better sense of your equity — and how its value may change over time.

3. What You’ll Learn Throughout This Module

This article gives you a starting point, but ESOPs come with important details that affect your ownership and decision-making. In the rest of this series, we’ll cover:

• Common types of equity compensation
• What an ESOP is and how it works
• How to decode ESOP-related terms with a jargon buster
• What a grant letter looks like and how to read it
• What happens to your ESOP if you leave the company
• How equity grows or loses value based on company performance
• The risks and rewards of owning company shares

By the end, you’ll have a clearer understanding of what equity ownership really means — and how to make the most of it.