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Board Approval of Equity Incentive Plan

The Board Approval of Equity Incentive Plan is one of a group of documents that formally chronicles the approval of a “resolution” by your startup’s board of directors. A resolution is a decision or objective that has been voted on (and was agreed to) by your startup’s board members. The process of formal documentation is generally reserved for important or significant resolutions – examples of this sort are the approval of a Restricted Stock Award, and the issuance of stock options to a given individual. Many less-impactful decisions involving your startup will be discussed and voted on by board members (replacing a non-critical vendor or changing the appearance of your employees’ uniforms might qualify), however – while these should always be recorded – they do not require formal documentation.

A Board Approval of Equity Incentive Plan enables your startup’s board of directors to allocate shares of Common Stock for issuance (via the Equity Incentive Plan), and to ratify the agreements by which those shares may be disbursed. In the Board Approval of Equity Incentive Plan generated by SmackDocs, methods of disbursal include the Option Agreement and the Restricted Stock Purchase Agreement (Exhibits B and C respectively). The stock plan also allows your startup’s board to seek stockholder approval for the issuance of the shares, and to exempt such issuances from the registration requirements of securities laws that apply to publicly-traded equities (if necessary).

Board Approval of Restricted Stock Purchase Agreement

The Board of Approval of Restricted Stock Award is one of a group of documents that formally chronicles the approval of a “resolution” by your startup’s board of directors. A resolution is a decision or objective that has been voted on (and was agreed to) by your startup’s board members. The process of formal documentation is generally reserved for important or significant resolutions – examples of this sort are the approval of a Restricted Stock Award, and the issuance of stock options to a given individual. Many less-impactful decisions involving your startup will be discussed and voted on by board members (replacing a non-critical vendor or changing the appearance of your employees’ uniforms might qualify), however – while these should always be recorded – they do not require formal documentation.

The Board Approval of Restricted Stock Award allows your startup’s board of directors (having established a fair market value per share of your startup’s Common Stock) to approve the stock purchase rights of the purchasee(s) named in the document. The Board Approval of Restricted Stock Award should be accompanied by a signed Restricted Stock Purchase Agreement from each purchasee. The Restricted Stock Purchase Agreement will detail how payment for the shares is to be executed (with cash, services, or by another method), and what repurchase rights your startup retains.

Board Approval of Stock Option Grant

The Board Approval of Stock Option Grant is one of a group of documents that formally chronicles the approval of a “resolution” by your startup’s board of directors. A resolution is a decision or objective that has been voted on (and was agreed to) by your startup’s board members. The process of formal documentation is generally reserved for important or significant resolutions – examples of this sort are the approval of a Restricted Stock Award, and the issuance of stock options to a given individual. Many less-impactful decisions involving your startup will be discussed and voted on by board members (replacing a non-critical vendor or changing the appearance of your employees’ uniforms might qualify), however – while these should always be recorded – they do not require formal documentation.

The Board Approval of Stock Option Grant allows your startup’s board of directors (per share value of your startup’s Common Stock having been determined) to transfer incentive stock options to one or more optionee(s) named in the document. It is your board’s prerogative to determine the number of shares of Common Stock each optionee will be entitled to purchase if and when the options are exercised. The Board Approval of Stock Option Grant generated by SmackDocs specifies an exercise price per share equal to the Common Stock valuation (or 110% of this amount should an optionee hold at least 10% of your startup’s outstanding common shares). Options in the SmackDocs version of this agreement have a 10-year (maximum) term, and are exercisable over a four-year period (48 months) with an initial 12-month vesting cliff.

Equity Incentive Plan

An Equity Incentive Plan is an arrangement under which equity compensation is provided to one of your startup’s employees or consultants for services rendered, a way of helping to preserve what are likely to be (as is the case with most startups) limited cash resources. Instead of cash, under the Equity Incentive Plan the employee or consultant receives non-cash compensation such as shares of Common Stock or stock options. This can be of benefit to your startup in ways besides cash preservation. For instance, an individual who owns Common Stock in your startup will probably be better motivated to help it succeed. Shares of Common Stock and stock options can also provide an incentive for individuals to remain with your startup should times become difficult. The Equity Incentive Plan can be attractive (or at least acceptable) to your critical employees and consultants because they receive compensation for services rendered that will have a greater future value than the cash they would have received today (immediately).

The Equity Incentive Plan generated by SmackDocs allows for the issuance of both stock options and Restricted Stock Awards.

Notice of Stock Option Grant

The Stock Option Agreement gives a service provider (an employee or a consultant) the right to purchase a specified number of shares of your startup’s Common Stock at a set price for a defined period.

The Stock Option Agreement generated by SmackDocs includes the following phrases:

Your startup has the choice of granting either incentive stock options (ISOs) or nonqualified stock options (NSOs). The primary difference between incentive stock options and nonqualified stock options is in the way that they are taxed (see table below).

Tax Treatment ISOs NSOs
Stock Option Grant: No tax consequences at the time of grant. No tax consequences at the time of grant.
Stock Option Exercise: No ordinary income realized on the “spread” when the stock options are exercised. The spread is the difference between the exercise price (specified when the stock options are issued) and fair market value of the shares on the date that the options are exercised. The spread may count toward the alternative minimum tax (AMT), but only if the recipient of the stock options is subject to the AMT in the year that the stock options are exercised.  Ordinary income is realized on the “spread” (the difference between the exercise price of the stock options and fair market value of the shares on the date that the stock options are exercised). If the recipient of the stock options is or was an employee of your startup, he or she must pay whatever tax withholding your startup is legally required to collect (on the spread) when the stock options are exercised. If the recipient of the stock options is a consultant or advisor, the spread should be reported as ordinary income on the Form 1099 that your startup issues to him or her at the end of the applicable year (the year in which the stock options are exercised). 
Sale of Common Stock: Either long or short-term capital gains on the entire “spread” when the shares of Common Stock (underlying the stock option) are sold. The spread is the difference between the exercise price of the stock options (determined when the stock options are issued) and the sale price of the shares of Common Stock.
 
For the capital gains to be treated as long-term, the shares of Common Stock underlying the stock option cannot be sold before (the later of): (a) two years from the date the stock option was granted or (b) one year from the date on which the recipient exercised the stock option.
Either long or short-term capital gains on the entire “spread” when the shares of Common Stock (underlying the stock option) are sold. The spread is the difference between the fair market value of the Common Stock (underlying the stock option) on the date that the options are exercised and the sale price of the shares of Common Stock.
 
For the capital gains to be treated as long-term, the recipient of the stock options must hold his or her shares for at least one year from the date on which the recipient exercised the stock option.

Under IRS regulations, only your startup’s employees are eligible to receive ISOs. On the other hand, NSOs are available to employees and to other categories of service providers (such as consultants, advisors, and directors). Your startup’s board of directors should determine whether the recipient of stock options will be granted an ISO or an NSO.

Under the IRS Code, only $100,000 of ISO value is exercisable in any calendar year (e.g., as a result of vesting). Suppose then that the ISO value exceeds $100,000 in a given year – how will this be addressed? In such situations, the portion of the stock options above the $100,000 limit will be treated as a NSO. Value of an ISO is calculated by multiplying the number of shares that will become exercisable in the applicable calendar year by the exercise price per share (for purposes of this calculation, the Common Stock’s current fair market value is irrelevant). For example, if 100,000 shares under a stock option vest and become exercisable in a calendar year and the stock option has an exercise price of $2 per share (making total value of the exercised options $200,000), fifty thousand of the shares will be deemed ISOs, and the remaining 50,000 shares NSOs. Except in the case of death or disability to the holder of the stock option, incentive stock options or ISOs must be exercised within three months of such holder’s termination (of employment) by your startup. Even if the startup itself consents to a longer period for the exercising of an ISO, the stock options will be treated as a NSO if the three-month interval has elapsed.

If an employee holds more than 10% of your startup’s stock (not counting unexercised stock options) when an ISO is granted, the exercise price must be 110% of (fair market) value of the shares of Common Stock on the date the stock options were awarded. In this scenario, the stock option term is restricted to 5 years (cannot be the normal 10 years).

The stock-options recipient may pay his or her exercise price with cash (by check or wire transfer), or with shares of your startup’s Common Stock. If the recipient wants to pay the exercise price with shares of Common Stock, your startup must withhold however many shares of Common Stock have a fair market value equal to the aggregate exercise price.

Stock options are not transferable except by a few exceptions, chief among them the death or disability of the recipient of the stock option.

Restricted Stock Purchase Agreement

A Restricted Stock Award, unlike a stock option (exercisable at some point in the future), gives the recipient shares of your startup’s Common Stock immediately for either cash or other consideration (such as services to be rendered).

Shares of Common Stock obtained under a Restricted Stock Award are often subject to a lapsing forfeiture restriction (or repurchase right by the startup if those shares were purchased for cash). This means that part or all of the shares may be repurchased by the startup if the recipient fails to provide the agreed-upon services or meet other commitments. The forfeiture restrictions of a Restricted Stock Award perform very much like vesting does with respect to stock options. Like typical vesting terms, forfeiture restrictions tend to lapse over a four-year period – with 25% of the shares fully owned by the recipient on the one-year anniversary of his or her start date at your startup, and an additional 1/48th of the shares owned outright each month over the subsequent three years.

Stockholder Approval of Equity Incentive Plan

The Stockholder Approval of Equity Incentive Plan is one of a group of documents that allows the stockholders of your startup to formally sanction or approve a “resolution” of your startup’s board of directors. A resolution is a decision or objective that has been voted on (and was agreed to) by your startup’s board members. A formal sanctioning or approval from your startup’s stockholders is generally reserved for important or significant board resolutions – examples of this sort are the approval of an Equity Incentive Plan, and the indemnification of a given individual or entity by your startup. Many less-impactful decisions involving your startup will be discussed and voted on by board members (replacing a non-critical vendor or changing the appearance of your employees’ uniforms might qualify), however those votes should not require formal sanction from stockholders.

A Stockholder Approval of Equity Incentive Plan authorizes the adoption of the Equity Incentive Plan (Exhibit A). The Equity Incentive Plan calls for a given number of your startup’s shares of Common Stock to be reserved for issuance, and for your startup’s officers to take whatever legal steps are necessary to facilitate this process.