InfoWorld January 30, You're in the final stages of joining a hot new high-tech company as CTO. It's down to cash and options. You can handle the negotiations about salary and perks. But what is that stock option agreement really saying? Between the lines of boilerplate and legal mumbo jumbo, it's difficult to see how this stock option agreement will play out in the long term.
What exactly is vesting? Who sets the exercise price? How do you exercise those options? And what exactly is negotiable? Once you've negotiated a stellar deal on the cost and quantity of options, it's time to figure out how you'll pay for those options.
The most straightforward payment is cash. But exercising options -- thousands of options -- can be expensive.
It is not uncommon for executives to face a cash flow crisis exercising that day arrives. Luckily, there are payment plans that you can stock into your stock option agreement. Many stock option agreements allow you to pay with company shares that you already own, provided you've had title to the shares for at least six months.
To do this, you arrange for an electronic swap of new shares with old. Those 50 shares will become Remember, this only applies to shares you own in your employing company. Stock held in another company cannot be used. Financing ipo with stock of another company require that those stocks be converted to cash. This means you would trigger a taxable event and probably have to pay capital gains taxes on those earnings, says Gabriel Fenton, an options expert with PaineWebber in San Francisco and coauthor of the book, Employee Stock Options: A Strategic Planning Guide for the 21st Century Optionaire.
Opt for a broker effectuated cashless exercise, referred to as a Regulation T Program. The broker essentially loans the money to exercise, sells the shares, and uses the proceeds to pay off the loan. Want to leave your other stocks intact? A company loan may be the answer.
That involves borrowing money from your company to exercise the options. You then sell the shares and pay the company back immediately, keeping the difference. Many companies are uncomfortable with the practice of loaning money to employees, but a company loan may be worth exploring. Negotiate up front -- when you're negotiating the stock option agreement and the number of options you'll be granted -- for a company loan. Make sure the company includes this financing alternative in the Grant Notice and that the language in the plan does not specifically prohibit it.
As with a bank loan, terms may vary significantly and won't be specified in the Notice, but at the time you request stock loan, according to Dunn. The best method of payment for you depends on stock circumstances, both now and in the future.
That's why our experts suggest negotiating for as many choices as possible. Of course, you don't know, so you want maximum flexibility," Dunn says. At the time your option is exercised, you agree to make adequate provision for any sums required to satisfy the federal, state, local, and foreign tax withholding obligations. The above term is commonly prior in stock option agreement plans. However, you may be able to negotiate how the taxes are paid: The sample Stock Option Agreement, for instance, gives the company the right to take options 28 percent withholding out of your future payroll, or if options want, to convert some of the shares to cash and use the cash as withholding.
ISOs have more favorable tax implications for employees. On the day you exercise Options, you'll have to satisfy federal, state, and local tax withholding obligations through cash payment, the withholding of shares from the options you exercised, or a swap of common stock you already own. Tax withholding exercising includes Social Security and Medicare tax and is required even if you don't sell the stock.
The sample plan, for example, requires stock options to vest completely within five years of the date of grant 20 percent each year if the company goes public. Mayfield and the other experts strongly advise anyone holding stock options to see a professional to help sort out the financial and legal kinks of the option deal.
To answer those questions, we had three experts evaluate a sample stock option agreement. Gabriel Fenton is an options expert with PaineWebber in San Francisco and co-author of the book Employee Stock Options: Step one on your stock option journey is to gather the key documents, say our expert panelists. Elementary as it may seem, many executives fail to see how various plan documents impact each other. By neglecting even one, you may be setting yourself up for problems down the exercise line.
What are and who has those key documents? The documents include the Equity Incentive Plan, the Grant Letter, the Stock Option Agreement, and the Notice of Exercise, all of which should be provided to you when the employment offer is made.
A word of start-up caution: Early-stage companies often do not have a plan in place. If that's the case, ask for a proposed plan draft. Other helpful resources include the Stockholder's Agreement and the Company Bylaws, which executives often must sign as a condition of employment.
These documents might include terms that could limit your ability to sell shares or require you to sell under certain circumstances that you may not have control over and that you may find less than ideal.
Terms that affect your subsequent cash flow and option wealth include rights of first refusal, which give the company rights to buy back your shares before you sell them to a third party; cross purchase provisions, which are your rights to purchase stock in subsidiaries of the employing company; and other rights of repurchase.
Access to the Stockholder Agreement or Company Bylaws doesn't mean you'll be able to alter stock terms, attorney Mayfield says. When negotiating with a privately held company, get your hands on a copy of the most recent business plan. Analyzing the business plan may give you insight as to whether your potential new employer has a shot at going public. If you're negotiating for stock options, don't assume you cannot review the business plan and other key documents, Mayfield says.
In other words, insist upon access to that information. Armed with the relevant documents, you can get down to the nitty-gritty of evaluating the stock option agreement. Here's what our experts say about sections of the sample agreement we provided them. Terms from the plan are denoted in italics. This is the bragging rights term: Ask about the total number of shares outstanding so you know what percent of the company you're getting.
Dilution is the word to ipo for: The more stocks or options a company issues, the more your ownership interest is diluted. To guard against this, you might focus on negotiating for a fixed percentage of the company rather than the number of options. The company would then have to increase your number of stocks or options every time dilution occurs, Mayfield says.
It's not unusual for start-ups to offer NSOs nonstatutory stock options -- which trigger taxable events -- without a Stock Option Agreement in place. Instead, your Employment Agreement may refer to the company's intention to create a plan and outline what those terms would be. It's a show of good faith on their part, but there's no guarantee they will ever "show you the money," according to Mayfield.
If you face that situation, Mayfield suggests negotiating a clause into your contract that provides for monetary compensation in case a Stock Option Plan never materializes. By the second anniversary, you'd receive another percentage, if there's still no plan, and so on," Mayfield says.
Notwithstanding the foregoing, a Nonstatutory Stock Option may be granted with an exercise price lower than that set forth in the preceding sentence if such Option is granted pursuant to an assumption or substitution for another option in a manner satisfying the provisions of Section a of the Code.
Start with the exercise price of ISOs incentive stock optionswhich prior non-negotiable due to Internal Revenue Service limitations. ISOs receive favorable tax treatment, so the IRS requires the exercise price to equal or exceed the fair market value of the stock on the date listed on the Stock Option Grant Notice -- the grant date. But NSOs -- options that don't meet IRS requirements to be ISOs -- are a different matter. You can negotiate the exercise price on NSOs within the company-imposed restrictions in the Stock Option Plan.
Our sample plan, for instance, states that the NSO exercise price cannot be less than 85 percent ipo the fair market value on the date of grant. This situation is possible, but fairly unusual, Dunn says. And since this reduces earnings, most companies will not want to do this," he says. Simply put, vesting is the "when" of playing your options, the date at which they become available to exercise.
But I interpret it to mean that you can exercise 25 percent of the shares in one year, and another portion of the grant vests every month thereafter until all are vested at the end of the fourth year," Dunn says. This ad options close ipo 20 seconds. Thank you Your message has been sent. Sorry There was an error emailing this prior. By Esther Chapman InfoWorld January 30, Opting for negotiation and understanding. Employers offer relief from drowning options.
Stock options are a betting proposition. Exercising options can be tricky Once you've negotiated a stellar exercising on the cost and quantity of options, it's time to figure out how you'll pay for those options. Withholding obligations At the time your option is exercised, you agree to make adequate provision prior any sums required to satisfy the federal, state, local, and foreign tax withholding obligations.
Gather the goods Step one on your stock option journey is to gather the key documents, say our expert panelists.