Stock Options

Options pool Equity grant considerations Considerations in determining equity grants Strike price Vesting Accelerated vesting Early exercise Option grant process and capitalization table management Option grant agreement forms Recommended capitalization table management tool: Carta Refresh grants Additional resources

Stock options are a form of equity compensation in which an employee is granted the right to purchase a certain number of shares in the company at a predetermined price (the "strike price"). These options usually vest over time, meaning that the employee can only exercise their right to purchase the shares after a certain period of time has passed. This is often done to incentivize employees to stay with the company and contribute to its growth. For private companies, the strike price is typically based on the company’s 409A valuation, which determines the fair market value of a share of common stock. The number of shares that can be granted to employees is typically determined by an options pool, which is established during the entity formation phase of the company. The options pool is a set percentage of the total shares outstanding and is reserved for future equity grants to employees.

Options pool

During the entity formation phase, each company will establish an adequate employee options pool.

Equity grant considerations

Equity compensation aligns incentives between the company and the employee base. It can serve as a great tool to attract and retain talent.

OCV recommends full-time employees to receive equity incentive in the business they’re helping to build. Equity is not available for workers hired as contractors.

Founders: see Company Equity Grant Guidelines here

Considerations in determining equity grants

Similar to cash compensation, equity grants should reflect a candidate’s:

Role & responsibility at the company

Experience level

market indications for comparable positions given the stage of development of the company.

Cash and equity compensation should be considered holistically as an overall package.

Equity grants should also consider the remaining options pool available for candidates and the overall capitalization table of the company.

Determination of equity considerations for employees is not an exact science.

Some platforms exist that charge users to access tracked comprehensive data on equity compensation:

pave.com

Founders can see our Company Equity Grant Guidelines here

Strike price

All option grants come with a strike price or exercise price based on the fair market value of the company’s common stock on the date of the grant. In private companies, the strike price or fair market value is determined by the company’s board of directors, often based on a third-party valuation report known as a 409A valuation. It is important to issue options at the prevailing fair market value to avoid negative tax consequences for the employees.

The strike price represents the price or an amount the employees need to pay in order to exercise their options. For example, if an employee has 100 vested options with a strike price of $1.00/share, they would need to pay the company $100 in order to convert their options into common shares in the business.

Vesting

Standard vesting schedule for employees is four years with a one year cliff.

Founders (including CEOs) will vest over a four-year period with no cliff (see

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Step 4: Issue equity to founders and advisors,

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Step 5: Establish the company’s options pool ).

Equity granted will typically vest over time to ensure that employees and founders who leave the company early do not receive the entire equity amount associated with the total issued. Vesting schedules will sometimes include a cliff which is a required minimum amount of time for vesting.

For example, consider an employee who has been granted 1% of the fully diluted equity of the company as options (where vesting can apply similarly as with common stock) with a four year vesting period and a one year cliff. In such a scenario, if their employment comes to an end at 6 months time, that employee would not have vested 1/8th of the total amount of options granted because they would not have reached the cliff of 1 year (which would mean a minimum of 1/4 of the options vests). This employee would vest 3/4 of their options at their third year of employment and be fully vested at their fourth year of employment.

Time-based vesting

Time-based vesting (described above) is considered the industry standard. There are established tools and common practices to manage time-based vesting plans.

Performance-based vesting

Performance-based vesting can offer additional benefits such as aligning incentives with company goals and motivating high performance. Performance-based vesting is generally more appropriate for the executive team than the entire company.

Compared to time-based vesting, performance-based vesting are more complex to design, administer, and evaluate. Setting specific performance criteria, measuring progress, and determining whether employees have met the criteria can be challenging. It’ll require significantly more administrative effort and resources. Additionally, employees may face greater uncertainty with performance-based vesting. If they do not meet the performance criteria, they may not receive the expected equity rewards. This uncertainty can affect job satisfaction and morale and create challenges to recruit talent. While performance-based vesting can motivate employees to achieve specific goals, it may not provide the same level of retention incentives as time-based vesting. Lastly, performance-based vesting plans often require thorough documentation and reporting to ensure that the company is compliant with accounting and tax regulations.

Accelerated vesting

OCV companies’ standard stock plans (including founder common share purchase) do not automatically grant vesting acceleration. The Board must approve any vesting acceleration (which can be added any time).

There are three tiers of potential acceleration schemes to consider for executive hires:

Double-trigger acceleration: All or a portion of unvested shares accelerate in the event of (i) change of control (M&A scenario) and (ii) termination without cause or resignation for good reason (i.e. the executive is laid off without cause or if they resign because of material reduction in salary, relocation of office, etc.). This means that the executive’s unvested shares accelerate in full when both (i) and (ii) occur, usually within 12 months. This is common and of no harm to the company.

Single-trigger acceleration upon a change of control: Executive’s unvested shares accelerate in the event of a change of control. This is not commonly seen in offer letters and may raise concerns in future rounds.

Single-trigger acceleration for termination/resignation: Executive’s unvested shares accelerate in the event they are terminated without cause or resign for good reason. This is akin to a severance-type arrangement, where if the executive’s service terminates, they get a portion of their unvested shares accelerated. This is also uncommon in offer letters, and not recommended unless there’s a compelling reason to do so.

When early stage companies allow for this type of acceleration, it is normally 3-6 months of vesting acceleration at most.

Vesting should not accelerate in an IPO. Shares would continue to vest as they did prior to public filing.

OCV (in our board capacity) would consider double-trigger acceleration for CEO and CTOs only based on company-specific considerations. Prior to Seed round, non-standard acceleration consideration is expected to be rare (only if there are very unique situations that warrant the consideration).

Early exercise

In early exercise, employees have the option to purchase shares of company stock at the exercise price, which is typically set at the fair market value of the stock at the time the option is granted. However, because the company is private and the stock is not publicly traded, the employee cannot sell the shares on the open market to realize their value.

Early exercise can have tax implications for employees. By exercising early, employees may be able to minimize their tax liability by initiating the capital gains holding period sooner. However, they may also incur tax liabilities associated with the spread between the exercise price and the fair market value of the stock at the time of exercise.

As of February 2024, early exercise is only available for options issued to CEOs prior to a company’s Seed round.

Option grant process and capitalization table management

OCV companies’ capitalization tables are managed by the legal team.

New Grants

OCV recommends a quarterly or semi annual batched process to minimize legal costs and administrative time spent on option grants.

To issue new grants, Founders need to compile new hire offer letters and required information listed this tracker (Company, Q[X] - Options Grants), and provide these to the legal team quarterly or semi-annually.

From the company’s EOR, Founders should be able to locate employee titles, email addresses, classification, and confirm employee start dates (and end dates where applicable). Equity amounts, vesting schedules, and a sign off date from the board can be found in the company’s ATS and human resources documentation.

It is the company management’s responsibility to review and confirm new hire start date, which is the vesting start date.

Employee Terminations / Departures

As part of an employee’s offboarding process, Founders need to notify the legal team the last day of employment to properly account for options vesting. This should be done as soon as possible instead of a batched process.

Option grant agreement forms

The Legal Team provides and drafts option grant agreement forms. Locally compliant option grant templates are available for the following countries as of November2023:

Argentina	Colombia	India	Mexico	Singapore	Ukraine
Australia	Czech Republic	Ireland	Netherlands	South Korea	United States
Brazil	Denmark	Italy	New Zealand	Spain	ㅤ
Canada	Germany	Japan	Portugal	UAE	ㅤ

Template language is preferred in most non-US countries where applicable and the above list of templates will be confirmed and updated prior to new options issuance.

Template language is periodically reviewed by local counsel, but because our US-based legal team is not licensed in all relevant jurisdiction(s), they cannot guarantee that those templates satisfy all the requirements of the relevant jurisdiction(s), which may pose some enforceability, tax, or other risks to the company. A disclaimer will accompany such templates, reflecting those limitations.

For other countries where the legal team is not licensed, local counsel licensed in those relevant jurisdiction(s) will prepare options grants and provide legal advice specific to the proposed options. Engaging with local council will provide companies with as much assurance as possible that the grants intended for issuance are enforceable, have no unforeseen tax or other consequences for the recipients, and satisfy the relevant requirements in those jurisdictions. The legal team will assist with engaging local counsel for that purpose and with negotiating the fees associated with their review.

Local counsel review for option grants will cost between $3,000 to $5,000 per instance.

Following the approval by the company’s board of options grants agreements, they will be released into the company’s capitalization management tool.

Note: Contractors are not eligible to receive equity / stock option grants.

For founders only: specific details on worker classification guidelines and payment terms for contractors are here.

Advisors are often engaged by startups for critical expertise and are usually compensated with equity. Refer to the Advisors handbook page for advisor compensation guidelines.

Recommended capitalization table management tool: Carta

Use OCV Portfolio Company Referral Link for 20% discount on first year subscription.

Starter Edition is recommended.

Document retention when canceling Carta subscriptions

A general list of recommended reports to download (some may not be applicable):

Cap table reports, including ledgers by type and class for each calendar and fiscal year-end, as applicable

Stock plan reports

Exercised and settled reports

Historical terminations report

Tax withholding reports

Rule 701 analysis worksheet

Transactions audit report

All documents from Library and Templates sections, including stock certificate legends

Board consents (if any)

409A valuations

Forms 3921 ( if applicable )

ASC 718 expense reports (both grant date and mark-to-market for all historical periods, if applicable)

Stakeholder contact ledgers and information

Cost center / Relationship history and information

Refresh grants

“Refresh grants" typically refer to the practice of issuing additional stock options or equity awards to employees or team members over time. These grants are meant to "refresh" or replenish the equity incentives that employees receive after their initial grants have vested or expired. Refresh grants are a common tool used by startups to retain and motivate employees, especially in competitive job markets where attracting and retaining top talent is crucial.

As a default, the initial options pool established at an OCV company launch do not include refresh grant allocations. The timeline from founding to Seed round is expected to be ~18 month in general. With a standard vesting schedule of “4 years & 1-year cliff”, most new hire grants would not have surpassed 50% vesting prior to Seed round.

Founders should consider employee retention and refresh grant allocation in determining options pool size as part of the Seed (and any future financing) round.

Recommendations:

Include refresh grant allocation in options pool proposal as part of the upcoming financing round (this is your budget in building out the refresh equity program)

Create a program / standard guidelines in administering refresh grants that meet the company’s goals and objectives.

The timing and criteria for refresh grants can vary widely from one startup to another. They are typically based on factors such as an employee's performance, tenure, and the startup's valuation or funding rounds. For example, a refresh grant might be issued every year or two to employees who have performed well and are seen as key contributors to the company's success.
Refresh grants are also subject to a standard vesting schedule.

Reminder: The main purpose of refresh grants is to ensure that employees have ongoing incentives to stay with the company and help it grow. As the initial grants vest or expire, employees may lose some of their motivation and ownership in the company. Refresh grants help mitigate this by providing a new set of equity awards.

Additional resources

https://www.cooleygo.com/what-is-a-section-83b-election/

https://www.ycombinator.com/library/9j-how-much-equity-should-i-give-my-first-employees