Stock Options: Don’t Forget Board Approval

If you are in the process of awarding stock options to employees or service providers, do not forget that you need (among other things) board approval of all stock option grants. This is required by the corporate law of Delaware, Washington, and I imagine almost every state corporate law in the country.

(In this post, I am not talking about LLC equity awards; LLC equity awards are something entirely different from corporate stock options.)

Board approval of stock options can be documented in minutes of a board meeting, or a unanimous written consent of the board.

You can find good examples of board minutes granting options, or board consents granting options, if you search on Google. But I would recommend you use your company’s law firm’s documents. They will have them to share with you. And they would probably prefer you use their forms, since they might be called upon at some future point in time to give a legal opinion on your capitalization, and it will help them do that if they have been involved with your equity issuances.

Why is it important that you promptly and fastidiously document board approval of stock option grants? Well, because if the options haven’t been approved by the board, they haven’t been appropriately awarded under the corporate law. This can give rise to a variety of complexities and problems.

In general, it is a good idea to check in with your corporate counsel before granting stock options. This does not have to be an expensive process, but the costs of not administering your stock option plan in compliance with all of the technical requirements can become very expensive.

For example, if you run over the Rule 701 mathematical limitations, it could actually delay your IPO or result in personal fines. This actually happened to Google. You can find more information about this in this Practical Law Article.

Below is a full-blown stock option grant checklist.

Prior to Granting Stock Options

  • Adopt a stock option plan – First, adopt a plan and draft standard stock option 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.
  • 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.
  • 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. Rule 701 has mathematical limitations, meaning–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 $5M in options during the last 12 months, make sure to provide the prospectus required by Rule 701.
  • 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.
  • 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 law of each state in which investors 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, give each recipient a copy of the stock option plan and their stock option agreements, and have them sign the agreements required under the plan.
  • Capitalization ledger- Update the capitalization ledger once the option is approved.
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