So, you want to grant a stock option in a privately-held corporation? Here’s how, in 10 easy steps…
Step 1: Have legal counsel prepare an equity incentive plan, form of option grant notice, option agreement, notice of exercise, and board and stockholder consent. These documents can be tailored to the company’s specific needs.
Step 2: Have the company’s board of directors sign the consent approving the plan and agreement.
Step 3: Within 12 months of the board approval date, have the company’s stockholders approve the plan. This is necessary if you want to grant incentive stock options and if you want to use California’s 25102(o) blue-sky exemption.
Step 4: Recommended by not absolutely necessary: Have the board obtain a private tax code Section 409A valuation of the company’s common stock.
Step 5: Determine the state of residence of the service provider to whom you’d like to grant the stock option and have legal counsel verify that a state securities exemption is available.
Step 6: Have legal counsel draft board minutes or a board consent approving the option grant. If the company has a general counsel or stock plan administrator, they can assist in this process.
Step 7: The board approves in a meeting, or by written consent, the terms of the specific option grant, including: recipient, exercise price (which should be equal to or greater than the underlying stock’s fair market value), number of shares, vesting schedule, and whether the stock option is an incentive stock option or a nonstatutory stock option. The stock option recipient needs to be providing services on the option grant date, which will generally be the date the option is approved by the board.[1]
Step 8: The stock option recipient is provided with a grant notice to sign, and also provided copies of the equity incentive plan, form of option agreement, and notice of exercise.
Step 9: When the stock option recipient is ready to exercise his or her stock option, he or she provides the company with an executed notice of exercise and a check for the exercise price. If the option is a nonstatutory stock option and the option holder is, or was at the time of grant, an employee, the check will also need to cover the employee-portion of the required tax withholding.
Step 10: If the exercised stock option is a nonstatutory stock option, the company completes any necessary tax deposit with the applicable tax authority and reports the income recognized on a Form W-2 or Form 1099-MISC, as applicable. If the stock option is an incentive stock option, there is no tax withholding, but the company reports the exercise on a Form 3921. The applicable form (W-2, 1099, or 3921) is sent to the option holder and the IRS at the beginning of the subsequent calendar year. The company provides the option holder with a share certificate for the purchased shares, or in the case of uncertificated shares, simply adds the shares to the company’s cap table.
Mike Baker frequently advises with respect to the granting of stock options. He possesses a breadth and depth of experience in tax and employee benefits & compensation law that spans multiple decades. For additional information, please contact mike@mbakertaxlaw.com.
[1] Service on the date of grant is required under most forms of equity incentive plan and is required if the company would like to use Rule 701, which is the federal securities exemption used for most option grants in private companies. There are a few other requirements to satisfy Rule 701. See here for more detail.