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David P. Horne, Attorney at Law

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Stock Options and Equity Compensation Plans

Stock options and other forms of equity compensation are an essential form of employee incentive for many companies.  For startup companies, options represent a currency necessary to supplement salary which may be limited by available funds (but note that stock options or restricted stock awards do not satisfy minimum wage requirements applicable to all businesses).  We prepare equity compensation plans, stock option agreements and stock purchase agreements for companies and review these materials for individuals.  We also prepare the related approval documents for the board of directors and for the shareholders and the required California securities law filing.

Most equity compensation plans provide for the issuance of incentive stock options (ISOs), nonqualified stock options (NSOs), restricted stock and other forms of equity awards.  The tax treatment of equity compensation is a minefield for both companies and employees.  Many stock issuances, including stock option exercises, can be taxable events for employees and trigger withholding and reporting obligations for the issuing company.  ISOs and NSOs are subject to very different tax treatment.  We help companies and individuals understand the differences between the various flavors of equity and counsel regarding the suitability of each kind in specific situations.  A company should always advise an employee who receives or exercises a stock option, or who receives restricted stock, to obtain advice from the employee’s own tax advisor based on the employee’s individual tax situation.

Common stock is the basic unit of ownership of a corporation.  Stock options are not stock but represent a right to purchase stock at a specified price for a certain period of time (typically 5 – 10 years) and subject to certain conditions (typically continued employment for 1 – 5 years).  The exercise price of a stock option must be at least the fair market value of the underlying shares on the date the option is granted.  The determination of fair market value for purposes of stock option grants may require an appraisal from an independent valuation consultant.

Options are usually not exercisable until the underlying shares have vested (no longer subject to repurchase by the company at cost – see discussion of restricted stock below).  Early exercise options allow for the purchase of unvested shares, which then work much like restricted stock.  Net exercise options allow the option holder to exercise by surrendering a portion of the underlying shares to pay the exercise price, based on an increase in the value of the common stock since the option grant date, and avoid the need to pay the exercise price in cash (although fewer shares are received).

A restricted stock purchase agreement provides for the issuance of common stock, usually subject to vesting.  Vesting is a right of the corporation to repurchase shares from a founder or employee at cost (often significantly less than fair market value) until certain milestones are achieved, such as continuous employment for a period of years.  An important tax election under Section 83(b) of the Internal Revenue Code, must be made within 30 days of a restricted stock award (including the exercise of an early exercise stock option) in order to avoid future taxation as the shares vest.  Employees should always consult their own tax advisor in connection with a Section 83(b) election because of the potential for additional tax in the year the election is filed.

We assist with the approval, implementation and tracking of stock options and other forms of equity compensation for your company.  We also explain different forms of vesting for stock options and restricted stock, including early-exercise and net exercise stock options.

“David Horne has been an immense help in the start of my business. He has helped me network with contacts needed to develop the company by providing valuable introductions and has been extremely helpful with legal instructions. I’m very lucky to have found David. If you’re looking for someone to help you with your startup, look no further. David’s the best!”
Startup Founder
San Francisco, CA

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