In Stock Options 101, we discussed the establishment of a stock option plan and the key considerations in establishing such a plan. Once your company has established a stock option plan, the company may grant options to its employees, contractors, or advisors (known collectively as "Recipients").
In this article, we focus on the details of granting options to Recipients and key considerations for entering into an option agreement with a Recipient.
The stock option agreement
The stock option agreement is an agreement between the company and a Recipient which sets out the specifics of that Recipient's rights to exercise its option to buy shares. Each option agreement will also set out any differences between the general terms of the stock option plan or the form of stock option agreement attached to the option plan.
The stock option grant date
The grant date is the date the stock options are granted to the optionholder, as well as the date that they agree to be bound by the terms of that option agreement. The grant date should reflect the date that the options were offered to the Recipient, and approved in accordance with the provisions of the stock option plan.
How to determine the number of stock options to grant each Recipient
In order to decide how many stock options to offer to each Recipient, you will first need to consider the size of your overall option pool and the position that individual Recipient has in your company.
Your overall option pool should be considered carefully and should represent a minority of the capitalization of your company. Usually, without exceptional circumstances, option pools are set between 10 per cent and 20 per cent of the issued and outstanding capital of your company. This is usually considered a standard option pool, which allows the corporation to pursue different ways to use equity going forward.
Your overall capitalization structure should also allow you to issue many shares, rather than fractions of shares. For this to be possible, and for the founders to maintain a majority ownership, you should think about the existing shares in the hundreds of thousands, or millions, and the option pool in the same way.
When considering how many options to grant each Recipient, a company will want to consider what percentage of the option pool is being used and what percentage of overall company ownership that grant could represent, if exercised. The main factors to consider when deciding how many options to grant a Recipient should be: the skill level, seniority and contribution of the Recipient to the company.
You may also consider implementing a tiered system to the number of options granted based on position or seniority. In determining the percentage for each tier, the number of options must be high enough to be appealing and achieve the goal of incentivizing Recipients.
Setting the exercise price
The exercise price is often referred to as the strike price. Your overarching option plan may have a suggested exercise price included in it, but each new option agreement should re-evaluate whether the exercise price should be adjusted.
If the exercise price does not reflect the fair market value of the shares on the date of the option agreement, the company/Recipient may face unintended tax consequences unless the option is granted by a Canadian-controlled private corporation and certain other tests are met.
When to modify the vesting schedule in an option agreement
The option plan will usually provide that the option agreement is subject to a vesting schedule. Sometimes, there is a default vesting schedule set out in the option plan. Similar to the exercise price, you may choose to use the default vesting schedule set out in the option plan, or modify the terms of the vesting schedule in each option agreement when and if appropriate. Usually, without exceptional circumstances, corporations will allow options to vest over a 4 year period, with no shares vesting in the first year after the option grant.
Longer vesting schedules are common to achieve the goal of retaining and incentivizing Recipients. While time-based vesting may work for some Recipients, there may be certain individuals the company may only be able to incentivize using performance-based vesting or by using a combination of time and performance based vesting.
If the vesting schedule is modified for an option agreement, the vesting schedule must still comply with any minimum vesting conditions contained in the plan under which the option is being granted.
Expiration of the options
The option agreement will provide for a period of time that each Recipient may exercise their options after those options have vested. Recipients are not required to exercise their option to acquire shares immediately, and instead have a period of time to exercise their options.
Typically, options, once vested, may be exercised by the earlier of a certain date a number of years from the initial vesting, or when the Recipient leaves the relevant company. If the stock option is not exercised during the exercise period, it is often forfeited.
There are occasionally events that may cause either options to vest more quickly, or option agreements to terminate more quickly. These events are set out in the option plan, and highlighted in the option agreement where possible.
Conclusion
Option plans established by a company are typically guidelines for the granting of options to individual Recipients. Many provisions contained in the plan provide that determinations may be made in the sole discretion of the board of directors, allow the directors of a company to customize each option agreement for the circumstances of that particular Recipient.
The terms of the option plan should only be modified when and if appropriate to provide consistency in a company's equity compensation strategy.
To learn more about granting stock options, please contact the authors or any member of Gowling WLG's Tech Group.