Technology Law Experts
The Practical Tech Lawyer: How a Private Company Should Time Stock Option Awards
In an earlier blog, I summarized my recommended best practices for private companies that use equity compensation. At the risk of repeating myself, I thought readers would appreciate a quick summary of those best practices as they relate to the timing of stock option awards.
The challenge here is to make sure that the exercise price of every stock option is equal to or more than the fair market value (FMV) of an underlying share on the date the award is made. How your board of directors or compensation committee approves awards, how often you obtain independent company valuations, how your board updates those independent valuations and other factors all play a role in determining whether that exercise price is high enough. If it's not high enough (that is, if the exercise price is less than the FMV of an underlying share on the date the award is made), then you are creating tax problems for your option recipient and accounting and possibly securities problems for the company.
To avoid those pitfalls, I recommend:
- Timing: Only grant stock options on the same day as meetings of the company’s board of directors (or authorized committee), where the board also makes a determination of the company’s value, even if it is only an affirmation of a previous valuation. All new employees who started work after the last meeting can receive awards together at the next meeting. Vesting can be shortened to coincide with anniversaries of each new employee’s start date.
- Live Meetings: Try to avoid making option awards by written consent. This practice used to be OK, but now it carries more risk (if one of your directors takes too long to send back a signed consent, the FMV may have changed in the meantime).
- Don’t Commit to Stock Option Pricing Before the Board Meets. Employment offer letters should say the exercise price will be determined by the board of directors (or committee) at its next meeting. Otherwise you risk making an award with an exercise price (as promised in the offer) that’s different from the actual value of the underlying security when the award is approved by the board. This is not a huge risk for private companies with slow-changing valuations, but it's a risk all the same.
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© 2014 by Robert G. Schwartz, Jr. All rights reserved Disclaimer: This summary is provided for educational and informational purposes only and is not legal advice. Any specific questions about these topics should be directed to an attorney.