Stock options 103: Managing option exercises in Canadian tech startups

Previously in Stock options 101: How Canadian tech startups can use stock options to reward and retain workers, we discussed the establishment of a stock option plan and the key features of a plan. In Stock options 102: Considerations for Canadian tech startups entering into option agreements with workers, we outlined key considerations when granting options and entering into an option agreement. In this article, we focus on the steps a company should take when an optionholder exercises the option to buy shares.

Exercising stock options

Following the initial step of options being issued (as set out in Stock options 102), the options will vest (become available for purchase by the optionholder). Exercising stock options means that the optionholder is choosing to buy shares of the company's stock at the agreed upon exercise price pursuant to the stock option agreement and providing notice to the company of this choice. The process for this exercise will be set out in the company's stock option agreement and stock option plan.

Vesting and acceleration

Each option agreement will set out the terms of the vesting of the options. Usually, options will vest over a period of time, such as three years, and vest in intervals over that period of time, such as every year, every quarter or every month. This is called a vesting schedule.

Certain events may trigger accelerated vesting meaning that an optionholder will be able to exercise their option to buy shares ahead of the vesting schedule. Common triggering events may include an investment in the company of a certain amount, the sale of the company or a change in control of the company. Whether vesting will accelerate on a change in control may be set out in the plan, in the option agreement or left to the discretion of the board of directors.

Once options have vested, they may be exercised by an optionholder until they expire. The expiration date of the options should be set out in the option agreement and the company may choose any date that is reasonable for an optionholder to exercise their options. This may be based on a certain period of time from the vesting of the shares or triggered by a specific event (such as the sale of the company, or the termination of the optionholder, if the optionholder is an employee of the company).

The expiry of the options may be accelerated following termination of the optionholder. The company's option plan will likely provide an exercise period following termination for the portion of the optionholder's vested options while any unvested portion will expire immediately on the termination date.

If the option is not exercised during the exercise period, the option is forfeited.

The stock option notice of exercise or exercise agreement

A company will provide a form of stock option notice of exercise or stock option exercise agreement to its optionholders. This exercise notice is typically a form attached to the stock option agreement. When returned to a company, the exercise notice evidences the optionholder's election to buy shares, identifies the number of shares being purchased, the price per share and the method of payment. The exercise notice is accompanied by payment for the purchased shares and the delivery of any required documents.

Share restrictions upon exercise

An optionholder does not have rights as a shareholder until the optionholder has exercised the option and the shares are issued by the company. In order to make sure that the optionholder remains the owner of the shares following an exercise, each option agreement should include a provision that requires an optionholder to be bound by additional share restrictions once their option is exercised. These restrictions are typically contained in either:

• the plan;
• individual option agreements; and/or
• a shareholders' agreement that all individuals must become a party to when they acquire shares.

Most often, the option plan will include a provision that the board of directors may require an optionholder exercising their options to sign and become party to a shareholders' agreement or to agree to certain specific share restrictions. The corporation's obligation to issue shares will then be subject to the delivery of a document from the optionholder that agrees to be bound by the share restrictions.

Issuing shares

Once a company has received proper exercise notice, payment and satisfaction of any other requirements set out in the option plan and agreement, it will issue shares to the optionholder.

The company is responsible for keeping available at all times the number of shares required to satisfy options granted under the stock option plan. It is essential for a company to maintain updated records tracking the number of options granted and the vesting, expiry and forfeiture of options.

Once a company has ascertained that the shares are available for issuance, a company must obtain the correct approvals to issue the shares. The plan will identify whether consent of the board is required before issuing shares. Consent of the board, if required, is usually obtained by written resolutions signed by all the directors of the company.

The company will then issue a share certificate or a notice of uncertificated shares and update its shareholder register.

Contact your legal counsel

Granting stock options is a beneficial way to incentivize and attract talent; however, granting stock options and later processing an exercise of such options should be carefully executed to maintain the integrity of the company's capitalization and corporate records. Consulting your legal counsel will ensure that appropriate approvals are obtained, the proper issuance of shares and that the company's minute book is properly maintained.

Conclusion

When granting options and issuing shares pursuant a grant, there are a number of considerations and key steps a company should take to avoid common mistakes that can be time consuming and expensive to rectify after the fact.

To learn more about issuing shares pursuant to an option grant, please contact the authors or any member of Gowling WLG's Tech Group.