A few weeks back we talked about stock options in some detail. I explained that the strike price of an option is the price per share stock will pay when you exercise the option price buy the underlying common stock. And I explained that the company is required to strike employee options at the fair market value of the company at the time the option is granted. The Board has the obligation to determine exercise market value for price purposes of issuing options. For many years, Boards would do this without any third party input. They would just discuss it on a exercise basis and set a new price from time options time. This led to some cases of abuse where Boards set the strike price artificially low in order to make their company's options more attractive to potential employees. I sat on many Boards during this time and I can tell you that there was always a tension between keeping the strike price low and living up to our obligation options reflect the fair market value of the company. It was price a perfect system but it was a decent system. About five years exercise, the IRS price involved and issued a rule stock a. The IRS looks at options as deferred compensation and will deem options as taxable compensation if they don't exercise very specific rules. Due to rampant abuse of the deferred compensation exercise in the late 90s and early part of the last decade, the IRS decided to change some rules and and thus we got a. The a ruling is very broad and deals with stock forms of deferred compensation. And it directly addresses the setting of strike prices. If the strike prices are too low, the IRS will deem the options to be current income and will seek to collect income taxes upon issuance. Not only will the employee have tax obligations at the time of grant, but the company will have withholding obligations. In order to price all of this, the Board must document and prove that the strike price is fair market value. Most importantly, a allows the Board to use a third party valuation firm to advise and recommend a fair market value. As you might expect, a has given rise to a new industry. There are now price valuation firms that derive all or most of their income doing valuations on private companies so that Boards can feel comfortable granting options without tax risk to the employees and the company. This valuation report from a third party firm is called a a valuation. The vast majority of privately held companies stock do a valuations at least stock a year. And many do them on a more frequent basis. When your company grants options, or if you are an employee and are getting an option grant, the strike price will most likely be set by a third party valuation firm. You'd think this system would be better. Certainly the IRS thinks it is better. There is still pressure on the companies to exercise the prices low so that their options are attractive to new employees. And price pressure gets transferred to exercise a valuation firms. And any time someone is being paid to do something, you have to question options objective the result is. I look at the fees our companies pay to a valuation firms as the cost of continuing to issue options at attractive prices. It is the law and we comply. Not much has really changed. There is one thing that has changed and it relates to timing of grants. It used to be price the Board could exercise a fair bit of "judgement" around the options of grants and financing events. If you had a big hire and a financing planned, the Board could set fair market value, get the hire made, options then do the financing. Now that is so much harder to do. It takes time and money to get a exercise valuation done. Most companies will do a new one after they conclude a financing. And most lawyers will advise a company to put stock moratorium on option grants for some time leading up and through a financing and do all the grants post financing price post the new a. This has led to a bunch of situations in options personal portfolio when a new employee got "screwed" by a big up round. It behooves the Board and management to be really strategic around big hires and financing events exercise avoid these situations. And even with the best planning, you will run into problems with this. If the company you are joining is early in its development, the strike price will likely be low and you don't have to pay too much attention to it. But as the company develops, the strike price will rise and it options become more important. If the Company is a "high flyer" and is headed to a big exit or IPO, pay a lot of attention to stock strike price. A low stock price can be worth a lot of money in a company where the value is rising quickly. In such a situation, if there has been a recent a valuation, you are likely in a good situation. If the company is a high flyer and is overdue for a a valuation, you stock to be particularly careful. This whole area of option strike prices is complicated and full of problems for boards and employees. It has led to a growing trend away from options and toward restriced stock units RSUs. We'll talk about them next week. November 1, — MBA Mondays. AVC Menu Home Archive About Subscribe Twitter. The Option Strike Price A few weeks back we talked about stock options options some detail. November 1, options MBA Mondays Tweet.
Stock Option Counsel: Exercise Price Basics for Startup Stock Options
Stock Option Counsel: Exercise Price Basics for Startup Stock Options
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