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:

  • Exercise price. This is the price per share of Common Stock that the recipient must pay (to buy his or her shares) if the stock option is exercised. The exercise price will normally be equal to the fair market value per share of your startup’s Common Stock on the date the option is granted;
  • Vesting schedule and vesting commencement date. The Stock Option Agreement generated by SmackDocs prohibits the exercising of stock options until the shares of Common Stock have vested (vesting will occur over an agreed-upon period – if the stock recipient continues to provide your startup with services). Not familiar with vesting? Vesting is a way for a recipient to earn shares of stock underlying stock options over time, as certain predefined objectives are met. The objectives in question can be time-related (the recipient remains with your startup for an agreed-upon period) or performance-related (the recipient completes a project or a series of projects for your startup). After shares of Common Stock underlying stock options have vested, the stock option may be exercised to purchase the vested shares of Common Stock. A typical vesting schedule is four years long – with 25% of the shares of Common Stock underlying the stock option earned after one year of services, and an additional 1/48th of the shares earned each month over the subsequent three years of services.
  • Founders and certain senior executives (the CEO, CFO, CTO, etc.) of some startups are granted (as part of a Stock Option Agreement) full or partial accelerated vesting of the shares of Common Stock underlying their stock options if they are: (a) terminated without cause; or (b) voluntarily leave their employment with the startup for good reason. Terminated “without cause” means that an individual has not been fired on performance grounds, or for engaging in criminal, dishonest, or morally questionable behavior or activities. Voluntary departure from a startup (with what is considered good reason) can occur if the conditions of a recipient’s employment or service to the startup suddenly change (for example, if the recipient’s role is changed from CFO to custodian). It should be noted that the Stock Option Agreement generated by SmackDocs does not provide for these contingencies.
  • The founders and certain senior executives of some startups receive full or partial accelerated vesting of the shares of Common Stock underlying their stock options if the startup is acquired by another entity, its assets are sold, or some other “change of control” event takes place. The accelerated vesting terms will be either “single trigger” (acceleration occurs on the close of the startup’s change of control) or “double trigger” (acceleration occurs if the startup has a change of control AND, as a result of this change of control, the recipient of the stock option is terminated). This accelerated vesting can affect anywhere from 25% to 100% of unvested shares. The Stock Option Agreement generated by SmackDocs will also not provide for these contingencies.
  • Term and post-termination exercise period. Stock options typically expire after 10 years (sooner than 10 years if the recipient’s services to your startup stop). Usually, the vested portion of a recipient’s stock options must be exercised within three months of his or her termination date or they expire. If a recipient’s termination is due to death or disability, under most conditions the recipient’s estate will enjoy a longer period during which to exercise the vested stock options.

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.


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Equity Incentive Documents Package


Package Includes

  • Board Approval of Equity Incentive Plan
  • Board Approval of Restricted Stock Purchase Agreement
  • Board Approval of Stock Option Grant
  • Equity Incentive Plan
  • Notice of Stock Option Grant
  • Restricted Stock Purchase Agreement
  • Stockholder Approval of Equity Incentive Plan

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