A Primer on Stock Option Agreements and Restricted Stock Agreements

Why have a stock option plan?

Startups often prefer to compensate using stock options because it does not require a cash outlay. In addition, employees may prefer the favorable tax treatment associated with stock options. Stock options also often give employees a stake in the long-term success of the company that salaries or bonuses often do not. 

What is a stock option?

A stock option is the right to acquire a certain number of shares of stock for a specific price (“exercise price”). Usually, the employer does not permit an employee to exercise the right to purchase immediately on the date the stock option is issued. Rather, the right to purchase stock typically “vests” or accrues over a period of time or upon meeting certain company performance goals. This encourages employees to remain with the company for the rest of the vesting period or helps the company meet its goals. 

Tax consequences of Incentive Stock Options and Nonstatutory Stock Options

There are two forms of stock options: incentive stock options (“ISO”) and nonstatutory stock options (“NSO”). ISOs are different from NSOs in that ISOs receive favorable federal tax treatment if the option meets certain requirements of the Internal Revenue Code. When granted, both ISOs and NSOs should have an exercise price that is not less than 100 percent of the fair market value of the underlying stock. Neither ISOs nor NSOs are taxable upon grant to the employee or when the option vests. The difference between them lies in the tax consequences when the option is exercised. When an NSO is exercised, the employee recognizes compensation (ordinary) income in an amount equal to the spread at exercise. An employee does not recognize taxable income on exercise of an ISO. However, the spread at exercise is includible in the employee’s federal alternative minimum taxable (“AMT”) income and may give rise to AMT tax liability. 

If stock acquired upon exercise of an NSO is held for more than one year, any gain realized on the disposition of the stock is taxed at favorable long-term capital gain rates. ISOs must be held for at least two years from the date of grant and at least one year from the date of exercise to qualify for favorable capital gain tax rates. Otherwise, the employee recognizes compensation income that is taxed at ordinary income tax rates.

The other difference between ISOs and NSOs is in the benefit to the employer: for NSOs, the employer can take a deduction equal to the amount recognized by the employee upon exercise of the NSO. For ISOs, there is no deduction. The different aspects of ISOs and NSOs provide flexibility in tailoring an equity compensation plan to fit a company’s needs. 

What is restricted stock?

Instead of issuing stock options, some companies issue “restricted stock.” Restricted stock refers to stock that is transferred to an employee as compensation for services, subject to a vesting schedule. The employee usually is not required to pay for the stock. If the employee does not remain with the employer until the end of the vesting period, the stock must be returned to the employer. If the employee has paid any amount for the restricted stock but then fails to become vested, the employer usually refunds the purchase price to the employee. A discussion of the tax consequences of restricted stock is beyond the scope of this primer and requires a detailed conversation with a tax attorney.

Given the complex legal, accounting and tax issues, a company should seek advice before implementing an equity compensation plan.

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Rimon offers the following flat-fee packages:

• Stock Option Plan and Agreement:  $2400
  Initial Client Interview*
  Stock Option Plan
  Stock Option Agreement
  Board of Directors and Shareholders Approvals
  Spousal Consent
  Exercise Notice
  Filing the 25102(o) Notice with the Commissioner of Corporations**
  
  * Additional revisions at hourly rate
  ** Filing fee is calculated by the value of the shares in the Plan. The filing fee is additional.
  
   
• Restricted Stock Purchase Agreement:  $875
  Initial Client Interview*
  First Draft of Stock Purchase Agreement
  Stock Powers and Assignment
  Exercise Notice
  Spousal Consent
  83(b) Election Information
  Filing the 25102 Exemption with the Commissioner of Corporation**
  
  * Additional revisions at hourly rate
  ** Filing fee is additional ($25-$300)

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THIS IS ONLY A SIMPLE OUTLINE. WE STRONGLY RECOMMEND YOU SPEAK TO A LAWYER TO LEARN WHAT IS BEST FOR YOU. 
For a free consultation, or to learn more about our option agreement services, please contact us:
Email: .(JavaScript must be enabled to view this email address) Telephone: 800.930.7271