{"id":8178,"date":"2020-12-02T20:28:37","date_gmt":"2020-12-02T20:28:37","guid":{"rendered":"http:\/\/www-staging.carta.com\/sg\/?p=8178"},"modified":"2021-03-05T06:54:28","modified_gmt":"2021-03-05T06:54:28","slug":"issuing-options-mistakes","status":"publish","type":"post","link":"https:\/\/www-staging.carta.com\/sg\/blog\/issuing-options-mistakes\/","title":{"rendered":"Avoid these common mistakes when issuing stock options to employees"},"content":{"rendered":"

Issuing stock options<\/span><\/a> to your employees is a great way to attract new talent and increase retention. However, it\u2019s a complex and delicate process, and small errors early on can quickly balloon into expensive, time-consuming problems down the line.<\/span><\/p>\n

That\u2019s why it\u2019s important to understand the most common mistakes founders make when issuing options. By avoiding these basic pitfalls, you can create a stock option plan that both keeps you compliant <\/span>and<\/span><\/i> properly incentivizes your team.<\/span><\/p>\n

1. Getting the timing wrong<\/span><\/h2>\n

Once you\u2019ve decided to grant options, it\u2019s critical to <\/span>make sure you time these issuances correctly<\/b>.<\/span><\/p>\n

For example, issuing options late (e.g. after you\u2019ve received an investor term sheet) may force you to grant those options at a higher exercise price than you originally promised to your employees. As a result, they may be less motivated to <\/span>exercise their options<\/span><\/a>, or even worse, feel uninspired to stick around.<\/span><\/p>\n

That\u2019s why it\u2019s often a good idea to issue stock options <\/span>before<\/span><\/i> you have a term sheet in-hand. By doing this, you allow your employees to take advantage of a lower exercise price.<\/span><\/p>\n

2. Failing to get a 409A valuation (or update your previous one)\u00a0<\/span><\/h2>\n

Before issuing options as a private company, you need to get a <\/span>409A valuation<\/span><\/a> to determine the <\/span>fair market value<\/span><\/a> (FMV) of your company\u2019s common stock. This FMV helps you set the <\/span>strike price<\/span><\/a>, or the legal purchase price for each share.<\/span><\/p>\n

If you don\u2019t have a valid 409A valuation on file when issuing options, you risk exposing your company and employees to all sorts of potential tax penalties from the IRS. For example, if you issue options with a strike price that\u2019s <\/span>lower<\/span><\/i> than the legally-defined FMV, your employees could be charged significant interest penalties.\u00a0<\/span><\/p>\n

A one-time valuation also isn\u2019t enough. To avail yourself of the 409A safe harbor with the IRS, <\/span>you need to get a new 409A valuation every 12 months, or sooner if you have a material event or transaction, (like a new financing round).<\/span><\/p>\n

For these reasons, it\u2019s critically important to stay on top of your 409A valuations. At minimum, make sure you have a new valuation on the calendar every 12 months, and if you\u2019re in the middle of a major transaction, postpone any new option issuances until you have an updated valuation on file.\u00a0<\/span><\/p>\n

3. Not getting board approval for issuances<\/span><\/h2>\n

Another mistake many early founders make is issuing options without their board\u2019s approval first. The board has to approve all stock option grants ahead of time, either at a board meeting or by unanimous written consent. If your board hasn\u2019t approved an option grant, no options have actually been granted.\u00a0<\/span><\/p>\n

By the time you realize this as a founder, it could be too late. You may need to re-issue the stock options, and depending on how much your company\u2019s value has grown between now and then, these new options could end up carrying a higher exercise price than you originally promised your employees.\u00a0<\/span><\/p>\n

Luckily, you can avoid this problem by setting up a standard <\/span>board consent<\/span><\/a> procedure for stock option approvals. And you don\u2019t even have to schedule formal meetings. With the right software, such as <\/span>Carta<\/span><\/a>, your board members can approve option grants via email.\u00a0<\/span><\/p>\n

4. Thinking all stock options are the same<\/span><\/h2>\n

There are a few different types of stock options you can issue\u2014each with their own implications for your business and employees.\u00a0<\/span><\/p>\n

The most common types are <\/span>incentive stock options<\/b><\/a> (ISOs) and <\/span>non-qualified stock options<\/b><\/a> (NSOs). They differ in a few ways, namely: 1) whom they\u2019re for and 2) how they\u2019re <\/span>taxed<\/span><\/a>.\u00a0<\/span><\/p>\n

ISOs can only be issued to employees, whereas NSOs can be issued to employees <\/span>and<\/span><\/i> advisors, directors, consultants, and contractors.\u00a0<\/span><\/p>\n

In general, ISO holders don\u2019t have to pay taxes when they receive a grant or exercise their options (though some may have to pay the <\/span>alternative minimum tax<\/span><\/a>). NSO holders, on the other hand, have to pay taxes when they exercise <\/span>and<\/span><\/i> when they sell. Because ISOs can have special tax advantages, employees tend to favor them and may be more likely to exercise knowing they have an ISO.\u00a0<\/span><\/p>\n

However, there are also advantages and disadvantages for your company. For example, employers generally can\u2019t take a tax deduction with ISOs, but they can with NSOs. When deciding which type to issue, make sure you consider your long-term company goals and employee needs.\u00a0<\/span><\/p>\n

5. Failing to correctly track vesting schedules<\/span><\/h2>\n

Neglecting to create a proper <\/span>vesting<\/span><\/a> schedule can have dire consequences for your company\u2019s retention and cap table.\u00a0<\/span><\/p>\n

If employees don\u2019t understand how vesting works or can\u2019t track their own progress, they may be less motivated to stick around until the end of their vesting period. And if an employee leaves your company with their options only partially vested, it\u2019s difficult to work backward to make sure the unvested shares are properly reconciled on the cap table.<\/span><\/p>\n

Setting a vesting schedule and tracking it, however, can help. There are two types of vesting:<\/span><\/p>\n

Cliff vesting<\/b> is when employees receive 100% of their stock options all at once after a stated period of time.\u00a0<\/span><\/p>\n

Graded vesting<\/b> is when employees receive a portion of their stock options gradually over a certain number of years until they\u2019re fully vested.\u00a0<\/span><\/p>\n

Whichever route you pursue, make sure you implement a smart tracking and update system. That could involve hosting a quarterly <\/span>equity education<\/span><\/a> training for employees; sending employees emails before and when they hit vesting milestones; and tracking employee issuance dates and vesting progress on your cap table.\u00a0\u00a0<\/span><\/p>\n

Setting your company up for success<\/span><\/h2>\n

Making mistakes when issuing options can cost you time, money, and in the worst case, valuable employees. To avoid inadvertently complicating your cap table or de-incentivizing your team, it\u2019s important to make sure all your ducks are in a row <\/span>before<\/span><\/i> you issue stock options.\u00a0<\/span><\/p>\n

In addition to consulting your lawyers, consider investing in an equity management platform like <\/span>Carta<\/span><\/a>. As a founder, you can set up your cap table, issue electronic securities, request <\/span>409A valuations<\/span><\/a>, and even get easy board approvals. Plus, it\u2019s simple for your employees, too. They can accept electronic securities, exercise their options, and view their vesting schedules all in one place.\u00a0<\/span><\/p>\n

The result? You\u2019ll stay compliant, and your employees will have all the stock option information they need right at their fingertips.<\/span><\/p>\n

DISCLOSURE: <\/span>This publication contains general information only and eShares, Inc. dba Carta, Inc. (\u201cCarta\u201d) is not, by means of this publication, rendering accounting, business, financial, investment, legal, tax, or other professional advice or services.\u00a0 This publication is not a substitute for such professional advice or services nor should it be used as a basis for any decision or action that may affect your business or interests.\u00a0 Before making any decision or taking any action that may affect your business or interests, you should consult a qualified professional advisor.\u00a0 T<\/span>his communication is not intended as a recommendation, offer or solicitation for the purchase or sale of any security. Carta does not assume any liability for reliance on the information provided herein.<\/span><\/h6>\n","protected":false},"excerpt":{"rendered":"

Issuing stock options to your employees is a great way to attract new talent and increase retention. However, it\u2019s a complex and delicate process, and small errors early on can quickly balloon into expensive, time-consuming problems down the line. That\u2019s why it\u2019s important to understand the most common mistakes founders make when issuing options. By …<\/p>\n

Avoid these common mistakes when issuing stock options to employees<\/span> Read More »<\/a><\/p>\n","protected":false},"author":104,"featured_media":8179,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":[],"categories":[19,10,499],"tags":[26,423,18,426,427,368,424,425,428,82,83,61,419,420,422,417,418,421,429,186,105,79,12,99,84,45,93,29,46,430],"acf":[],"_links":{"self":[{"href":"https:\/\/www-staging.carta.com\/sg\/wp-json\/wp\/v2\/posts\/8178"}],"collection":[{"href":"https:\/\/www-staging.carta.com\/sg\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/www-staging.carta.com\/sg\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/www-staging.carta.com\/sg\/wp-json\/wp\/v2\/users\/104"}],"replies":[{"embeddable":true,"href":"https:\/\/www-staging.carta.com\/sg\/wp-json\/wp\/v2\/comments?post=8178"}],"version-history":[{"count":0,"href":"https:\/\/www-staging.carta.com\/sg\/wp-json\/wp\/v2\/posts\/8178\/revisions"}],"wp:featuredmedia":[{"embeddable":true,"href":"https:\/\/www-staging.carta.com\/sg\/wp-json\/wp\/v2\/media\/8179"}],"wp:attachment":[{"href":"https:\/\/www-staging.carta.com\/sg\/wp-json\/wp\/v2\/media?parent=8178"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/www-staging.carta.com\/sg\/wp-json\/wp\/v2\/categories?post=8178"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/www-staging.carta.com\/sg\/wp-json\/wp\/v2\/tags?post=8178"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}