Six Must-Haves for Stock Option Agreements

Plan Management Corp. was recently asked about what to include in employee stock option agreements. It is such a good question, that we thought we’d include our answer here as well.

The option agreement is the critical document used to clearly lay out the award terms in a way that the participant understands, and to avoid future litigation due to any misunderstanding. First, it is most important that participants realize an agreement is a legally binding document, and that they are signing off to the terms included, i.e., it is not just a memo that can be amended later. Once that is established, here are other items to have clearly included:

  • Non-compete, particularly for executives or early employees critical to success, you may want to make a non-compete part of the term of the agreement. If so, make sure it is explicitly laid out in the award agreement, in addition to any language in an over-arching employment agreement.
  • Be very clear on vesting – some issuers include fancy legal language about the vesting schedule, and we’ve actually seen some suits lately because the language was vague enough to leave room for interpretation. The most simple & effective is just to include a table with dates and vesting amounts, or for performance to make clear the amount of shares tied to each performance metric.
  • Make the expiration terms clear (include a definition of expiration), and note that the employee is responsible themselves for knowing when their awards expire and for taking any action accordingly.
  • Define any terms that may not be clear to participants – have a lay person outside of plan administration review to make sure it will be understood!
  • Clarify that there are tax events related to the exercise of options, and that the taxes are the responsibility of the employee, and that they will be withheld for employees from any exercise payout.
  • Depending on how strict you want to be with the agreement, you may want to include language about what happens if the agreement is not “accepted” (physically or electronically signed) by the participant. Some issuers do not allow exercise until it is accepted, and in some cases there is even a deadline by which the awards are cancelled if not accepted. Of course you will be best legally protected if you require acceptance.

As you can read above, the most important theme here is clarity! Trying to leave room for flexibility will more often than not become a liability down the road, so address any likely questions up front in the agreement. Some issuers are making the first page of the agreement into more of an executive summary format that is easy to read and clearly includes basic terms like grant date, shares granted, vesting schedule and expiration. This can be helpful, but make sure participants have the full agreement as well and that any signature still applies to the full set of terms.

Have questions, contact us today at [email protected]!