How do I grant stock options to employees?
EquityStock optionsEmployeesTax
Before the first option is granted the company needs an equity incentive plan, board approval of that plan, stockholder approval of it, and a current valuation of the common stock. After that, each grant is a board consent and two signed documents. Order matters: an option granted before the plan was approved, or priced below the valuation, is a defect that surfaces in diligence years later.
The plan and its approvals
The plan reserves a pool of shares and sets the rules every grant follows. The board adopts it and the stockholders approve it. For incentive stock options the stockholder approval has to come within twelve months before or after the board adopted the plan, otherwise no grant under it can be an ISO. No incentive stock option can be granted more than ten years after the earlier of the board's adoption and the stockholders' approval, which is why plans are written to expire then.
The valuation
An option must be priced at or above the fair market value of the common stock on the grant date. Priced lower, section 409A treats it as deferred compensation and the employee pays the penalty. For a private company, an independent appraisal no more than twelve months old is presumed to be a reasonable valuation, and that appraisal is the 409A valuation; refresh it after any financing.
The grant
The board approves each grant by written consent, fixing the recipient, number of shares, exercise price and vesting schedule. The employee signs a grant notice and an option agreement; an exercise notice comes later, when they buy the shares.
ISO or NSO
Incentive stock options go only to employees, must expire within ten years, and carry no ordinary income at exercise if the holding periods are met. Only the first $100,000 of options, by grant-date value, that first become exercisable in any one year can be ISOs; the excess are nonstatutory options, taxed at exercise on the spread. The grant also needs a securities exemption, which for a private company is nearly always Rule 701.
Arabella's Delaware option package carries the grant notice, option agreement and exercise notice, filled by one questionnaire. The plan and the stockholder consent approving it come with the incorporation packet. The board consent approving each grant is not a template today.
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Written by the lawyers who built Arabella. This is legal information, not legal advice for your situation, and reading it does not make us your lawyers. For a real dispute or a high-stakes decision, talk to a licensed attorney. More questions.