Stock Option Agreement: Main Terms and What to Look For
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What is a Stock Option Agreement?
A stock option agreement refers to a contract between a company and an employee, independent contractor, or a consultant. Employers use it as a form of employee compensation. Both parties submit to operate within the terms, conditions, and restrictions stipulated in the agreement. The party receiving the stock options is a highly valued employee who will earn the right to exercise stock options. In addition, the employee will be given the right to purchase the stock options at a pre-determined price.
A stock option agreement outlines the employee's rights. The company is granted stock options, which often involves a vesting schedule and exercise price or strike price. Once the options vest, the employee can purchase the options at the strike price in hopes of making a profit if the company’s stock value has appreciated.
Main Terms of a Stock Option Agreement
The stock option agreement has specific terms you should know. The terms help determine the scope and extent of the contract. For example, most stock options often have the following terms.
Parties to the Agreement
The agreement first lays down parties to the contract. Often, the parties are the company issuing the stock options and the employee receiving the stock options. The contract may refer to the employee as the optionee and the company as the optionor.
Stock Option Shares
Another term is the amount of option shares. This refers to the shares in the company that the employee will have the right to buy in the future. In the agreement, the number of options the employee is being issued.
Exercise Price
Another term in the stock option agreement is the exercise price. This is often the price the optionee has the right to purchase the shares. The exercise price, or strike price, is the fair market value of the company’s stock at the time of issuance. The exercise price can also be set at a discount or a premium to the fair market value.
Total Exercise Price
A stock option agreement will also have a total exercise price outlined for the employee. If the employee were to buy all of the options, the employee would have to pay the total exercise price to the company.
Effective Date
Another common term in a stock option agreement is the effective date. This is often the period within which the option becomes effective. For example, the effective date may be that day when the optionee signs the stock option agreement.
Conditions to Exercise
The other important term is the condition to exercise. The clause clarifies the conditions that must be satisfied before the stock option can be effective. While the optionee's commercial objective often determines the conditions of exercise, they aren't necessary. For example, another condition can be the time in the form of a vesting schedule.
Expiry Date
The other critical term in a stock option agreement is the expiry date. This period is when the option holder may exercise. The stock option agreement often terminates on the expiry date.
When entering into a stock option agreement, the parties often discuss the expiry date. However, different circumstances may determine and affect the actualization of the expiry date.
Here's an article about the terms of the stock option agreement
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What Should I Look for in a Stock Option Agreement?
When signing a stock option agreement, it's important to consider certain issues. Here're some factors to consider in a stock option agreement.
- Number of Shares. You must have clarity about the number of shares you can purchase. Before signing a contract, you must consider what options will be on your table now and in the future. Most times, factors such as vesting often affect the number of shares one can purchase.
- Exercise Price. Another element an optionee should look out to in an agreement is the exercise price. The price is often on the offer letter and stock option agreement. Ensure that the employee stock option agreement clearly defines the exercise price.
- Vesting Schedule. The standard vesting period is around four years and a one-year cliff. If you depart before the cliff, it's important that you also understand the consequences. You must pay attention to the vesting schedule on the agreement before making that important decision.
- Early Exercise of Option. You must pay attention to the exercise option on the agreement. Check to ensure that the contract specifies the possibility of letting employees exercise vesting earlier. The tax benefits in such cases are beneficial to the employee.
Before signing the contract, these are some important things to consider in a stock option agreement.
Here's an article on what to look out for in a stock option agreement
Can I Negotiate my Stock Option Agreement ?
It's always advisable for employees to negotiate the stock options before signing the agreement. Most times, employees feel inadequate where negotiations about stocks and salary are concerned. However, you can arrange your stock option agreement before signing it.
When negotiating, consider a background review of all the dynamics around the offer. Conduct your research to ensure that you are knowledgeably informed about the key terms you can negotiate.
Here's an article about negotiating a stock option agreement
Examples of Stock Option Agreement
Different companies offer varying plans for stock options for their employees. Here are some of the well-known examples of stock option agreements.
Wordlogic Corporation, 2012 Equity Incentive Plan Stock Option Agreement
The agreement was more of an incentive plan for employees. Therefore, the contract had some of the essential terms discussed. They include the purpose of the plan, the definition, the grant date, the expiry date, and the participants.
The terms also include the qualifying performance criteria. Here, employees can read through and note areas that may disqualify them from the contract. The plan's administration and the options are the other critical elements stipulated in the agreement.
Here's an article about an example of the stock option agreement
How Do Employee Stock Option Plans Work?
The employee stock options refer to a plan that's offered to employees. The plan stipulates the options to buy shares of the company's stock at a certain price for a specified period. The program can act as a supplementary source of income for the employee.
Investing in ESPP is a great idea, given that it can help employees meet short-term financial objectives.
Incentive Stock Options vs. Non-Qualified Stock Options
There're notable differences between incentive stock options and non-qualified stock options. One significant difference is that incentive stock options are only eligible to employees. The recipient must also be a person, so it can't be issued to entities like contractors.
On the other hand, non-qualified stock options are open to both employees and independent contractors. These may also include non-employee directors.
Both options are not taxable when granted. But taxes apply when you sell your shares, based on the exercise price and the current value of the shares. This is an important note.
The options have varying treatments regarding taxation upon exercise for income. For example, in the case of ISOs, it's taxable for amount but not income or employment tax. On the other hand, NSOs are only taxable for tax purposes and never for AMT purposes.
For favorable tax treatment, there's an annual limit of stock for ISOs, which is $100,000 in stock options that can become exercisable in any one year for any individual employee. However, there is no limit for NSOs.
These are some of the most important elements that separate ISOs vs. NSOs.
Learn more about ISOs vs. NSOs.
Get Help with a Stock Option Agreement
When it's your first time handling the stock option agreement, it's important to have a legal mind in your corner. So take your time to understand all the terms and elements of the contract.
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Can you explain the vesting schedule and exercise period in a Stock Option Agreement?
I recently received a job offer from a startup company that includes stock options as part of my compensation package. The company provided me with a Stock Option Agreement, but I am uncertain about the details regarding the vesting schedule and exercise period. I would like to understand how these provisions work, as well as any potential implications they may have on my ability to exercise the options in the future.
Darryl S.
These are KEY TERMS of such an agreement that dictate how and when you can access and use the stock options granted to you. Here's a detailed explanation of each: VESTING SCHDULE - The vesting schedule defines when you earn the right to exercise your stock options. You don't typically receive the full option rights immediately; instead, they vest (become exercisable) over a period of time or upon achieving specific milestones. This structure incentivizes employees or stakeholders to remain with the company or contribute to its growth. Options often vest over 3-4 years with a one year cliff (meaning you must staying employed at least 12 months to earn anything and after they vest monthly or quarterly). EXERCISE PERIOD - The exercise period (also sometimes called the "option exercise window") is the time frame during which you can actually purchase (or "exercise") the shares after they have vested. If you don't exercise within this window, the options may expire. Typically, you have up to 10 years from the grant date to exercise vested options, as long as you're still employed. If you leave the company, you usually have a shorter window (e.g., 90 days) to exercise vested options. - Options that are not exercised before the expiration date become void.
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Can a company revoke unvested stock options upon termination of employment?
I recently left my previous job and had unvested stock options as part of my compensation package. However, upon termination, the company informed me that they would be revoking all unvested stock options. I was under the impression that unvested options would still be available to me even after leaving the company, and I am now seeking legal advice to understand if the company's action is legally permissible or if I have any recourse to retain those unvested stock options.
Darryl S.
Generally when you leave a job you forfeit all rights to unvested stock options since those "vest" or "become yours" based on time worked at the company. If you have any stock options that have vested based on your work at the Company, those may or may not be forfeited depending upon what your Stock Option Agreement says. Please review that carefully or hire a lawyer to assist you to advise on next steps.
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How to amend a stock option agreement?
I recently accepted a job offer from a company that provided me with a Stock Option Agreement. After a few months in my role, I have realized that some of the terms of the agreement are not suitable for my current needs. I would like to know how I can go about amending the agreement to better suit my current needs.
Thomas L.
You need to propose your changes to your employer.
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Hello! My company provide me a fixed amount ($10,000) of equity within 4 years, with 25% vested after 12 months and said "The options will have a “strike price” which is based on the market value of the Company at the time your options are issued to you." What does it mean? Will i need to pay the different price every year?
Michelle F.
Would really need to see the documents to properly answer this question. Is the value of the equity fixed at $10,000? Typically you get a number of shares that vest (become available to you) over x amount of time. The strike price is the amount you will pay to the company to exercise the option. (Disclaimer: This is not legal advice.)
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I am an employee of a company that is planning to offer stock options as part of my compensation package. I am trying to understand what would happen if my company does a stock split. Would my stock options be affected by the split, and if so, how? I want to make sure I understand the implications of a stock split before I accept the stock options as part of my compensation.
Thaddeus W.
Good question! Typically, a stock split will result in an appropriate adjustment to an option award so that, after the adjustment, the option holder (you, in this case) is "made whole" -- that is, you are effectively in the same place economically (as far as this option is concerned) after the split with the option as you were before. If you look at your company's Stock Plan (the plan under which your options were authorized and granted to you), you will probably find a section called "Changes in Capitalization." (Or, you can search to document for the word "split" and may be able to find the governing provision that way.) The provision might be included in your Stock Option Agreement, but typically it is covered in the Plan. Anyway, the provision (wherever it is located in your documents) would normally say something along the lines of the following: "In the event of a stock split (and other events), the following will occur: (i) the numbers and class of shares covered by your option award, (ii) the exercise price per share of each outstanding option, and (iii) any applicable repurchase price per share issued under any option award, will be automatically proportionately adjusted in the event of a stock split (or other event)." (Usually the language is even more "legalesey" but that's pretty much the jist of it.) Of course, its impossible to say for sure in your situation (or in any other specific situation) without seeing the relevant documents and knowing all other relevant details, but that would be the typical approach.
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