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When does my company need a stock option plan?

Stock planEquityTaxGovernance

Before the first option is granted to anyone. An option is a contract giving someone the right to buy shares at a fixed price, and without a plan under which to grant it and a board resolution approving the grant, there is nothing to grant. Founder stock is not under the plan; it is issued directly. The plan exists for the first employee, the first advisor, the first contractor who wants equity. If none of those is on the horizon, the plan can wait.

What has to be in place

The plan document itself, which reserves a block of shares and sets the rules for grants. A board consent adopting it. Stockholder approval, which the tax code requires within twelve months before or after the board's adoption if any of the options are to be incentive stock options, the kind with favorable tax treatment for employees. A plan can grant options for ten years from adoption or approval, whichever came first. Most formation packets adopt the plan at formation, because getting stockholder approval is a signature from the founders while they are the only stockholders, and a meeting later.

The price, and why a valuation comes before the first grant

An option's exercise price has to be at least the fair market value of the stock on the grant date. That is a condition of incentive stock option treatment, and it is also the condition that keeps any option out of section 409A, which otherwise taxes the holder before exercise and adds a penalty. A private company shows fair market value with a valuation, and the regulations presume one is reasonable if an independent appraiser did it within the twelve months before the grant. Ordering the valuation is what usually decides when the first grant happens.

Incentive stock options also carry a cap: to the extent more than $100,000 worth of them, measured at grant, become exercisable for one person in a calendar year, the excess is treated as ordinary options.

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.