Employer’s Legal Guide to Stock Option Grants [Checklist]

Stock Option Grant Checklist

If you want to grant stock options to employees, consultants and advisors, you will want to take the time to do this right. It is easy to make a mistake in administering a stock option plan. There are a lot of details to track, and it is important you track them all.

Granting stock options in compliance with the law, including the corporate law and the securities laws, doesn’t require a lot of time, but it does require some. And if you don’t do this right, you will create a lot of headaches and problems for yourself down the road. (Including potentially having to offer to repurchase options or shares issued faultily.)

To help, we have put together this checklist. This checklist is generic. It is written for a corporation, not for an LLC taxed as a partnership. We hope you find this as a helpful guide, but we don’t advise you to do this alone. You should work with your legal counsel in administering your stock option plan.

Prior to Granting Stock Options

Adopt a stock option plan

First, adopt an equity incentive or stock option plan and standard agreements under the plan. If shareholders do not approve the plan, you cannot grant incentive stock options, and you may be required to make special filings with state securities regulators, so usually it is advisable to have the shareholders approve the plan. For example, if you grant stock options to service providers resident in Washington state, if the awards are not make pursuant to a plan under which ISOs can be granted (meaning, it has to be a shareholder approved plan), you have to give 30 days advance notice to the Department of Financial Institutions before you offer any options to Washington residents. In California, if your option plan is not shareholder approved, you can’t rely on 25102(o), the most widely available exemption for issuances of stock options.

Grant all of your stock options under the plan

If you are granting options outside the plan, special considerations will arise, which are not addressed in this checklist. For example, what will be your securities law exemption be for the option issued outside of the plan? If you are issuing options to accredited investors under Rule 506 you will have to file Forms D with the SEC and at the state-level as well, and pay a filing fee.

Confirm that you have sufficient shares

Prior to granting stock options, confirm you have the number of shares under the plan to grant the new batch of options.

Rule 701

Before every grant of stock options, confirm that you are compliant with Rule 701′s mathematical limitations. There is a limit to the number of securities you can issue under Rule 701, and you do not want to exceed that limit. For a summary of the limits, see: What Is Rule 701 and Do I Need to Worry About It? (Be aware that Rule 701 is only available to companies that are not subject to the reporting requirements of section 13 or 15(d) of the Securities Exchange Act.)

Prospectus

If you have granted more than $10M in options during the last 12 months, make sure to provide the prospectus as required by Rule 701. This dollar limitation was recently amended by the SEC, effective July 24, 2018.

Eligible recipients

Confirm each prospective option recipient is eligible under the plan. Generally, only individuals qualify. Non-employee/consultants can qualify as long as they are *natural persons* providing bona fide services and not receiving the options in connection with a capital raising transaction. This means you can’t grant an option to an LLC under your plan; you have to find a different exemption.

Confirm the residency of recipients

Before every grant of stock options, confirm the residency of the prospective optionees and confirm that you are compliant with the Blue Sky laws of each state in which the optionees are resident. If you are granting options to optionees in California, special attention will need to be given to California’s requirements.

Fair market value

Make sure that the options are being granted at fair market value in compliance with Section 409A of the Internal Revenue Code.

Board approval

Have the Board approve the option grants pursuant to a Board Consent or resolutions adopted at a meeting. If the vesting schedules for any of the options are different from the standard specified in the standard agreements, make sure the Board consent describes the vesting schedule.

Signed agreements

After each grant of stock options, make sure to give each recipient a copy of the plan and their stock option agreements, and have them sign the agreements required under the plan. It is a common mistake to somehow forget to give optionees a copy of the plan. At the same time, make sure your optionees have all signed the appropriate service-related agreements (including intellectually property assignment agreements).

Capitalization ledger

Update the capitalization ledger once the option is approved. You will want to make sure you maintain an accurate and up to date ledger of all equity issuances in your company.

Exercising Stock Options

Now that you have gone through the preparation process, check out our Stock Option Exercise Checklist when you’re ready.