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Ask Aliya: Are Stock Options the Best Incentives for Startup Employees?

Technology
“Ask Aliya” is a new column for lawyers who are the first legal hire at their company and need advice from an in-house lawyer who has been there before. Aliya Ramji is the director of legal and business strategy for Figure 1 Inc., a network used by more than 1 million healthcare professionals to share cases and collaborate. To have your legal questions for startups answered, email [email protected] with "Ask Aliya" in the subject line.

Dear Aliya,


The founder of my company wants to start rewarding employees using stock options. Is this a valuable way to reward employees? What do I need to do to start the process? What advice should I give our founder?

Oleg

Dear Oleg,


Stock options as incentives are great for the morale and accountability of employees at a company. An option is the right to buy shares in a company at a specified price. Options are worthless until and unless an employee is able to exercise the options. In the case of a startup, this is when an exit event occurs — either a sale or an IPO. Employee ownership is an important part of many companies today and it is an especially important part of startups. Using stock options as incentives reinforces that everyone is on the same team, everyone shares the company’s success, and all employee interests align. Options make everyone at a company think and act like the owner.

In order to issue options to employees, you must first adopt a stock option plan. The plan will have to be approved by shareholders. You may need to amend your articles of incorporation or your corporate charter depending on the number of shares you are authorized to issue and the pool of options you want for your employees. In your option plan, you must incorporate a vesting schedule. Option plans generally have a one or two-year cliff, meaning options do not vest, or become non-forfeitable, until an employee has worked for one or two years at the company. After that, options vest based on the company’s schedule. Occasionally, you may need to change the vesting schedule: Make sure your employee stock option plan has a clause for amendments.

Your filing requirements will depend on whether the company is a public or privately held corporation, and on the country, state, or province of incorporation. Ensure that you fulfill all the requirements to issue new securities and ensure you are granting options to individuals only. Also confirm the residency of each recipient of options. Your options will have to be granted at fair market value and this will need to be in accordance with Section 409A of the Internal Revenue Code. There are plenty of companies that will do 409A valuations for you — leave it to the experts.

Each option grant will need approval from the board. This can be done by consent or by resolution. I usually have all the option grants approved by resolution at every quarterly board meeting. If the vesting schedule for any grants is changed from the standard vesting schedule, the board will generally need to approve. Once a grant is approved, the employee should sign the standard stock option agreement outlined in the option plan.

I've personally seen the effects of stock option plans on company culture and can tell you how much of a difference it makes. People are almost always more passionate about making the company better when they have a personal stake. Implementing stock option plans takes work, though, and putting a plan together requires strategy and legal drafting. If you have not drafted or designed employee stock option plans and agreements before, be sure to enlist the help of outside counsel. They will guide you through the process.

Good luck,

Aliya 

 

Photo credit: Purple Canvas Photography


The above is for informational purposes only. It does not constitute legal advice and cannot be used as such. For additional resources and support, please ensure proper legal advice is obtained.

About the Author

Ramji, AliyaAliya Ramji is the director of legal and business strategy for Figure 1 Inc. She also was a 2016 recipient of ACC’s Top 10 30-Somethings.


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