Many employees are unsure of how stock options function
without a well-thought-out strategy. Study shows, 69% of workers believe their
employer must explain how their equity functions, yet only 37% of workers'
employers offer sufficient equity education.
Stock option exercise provides you the legal right to purchase shares of the
company's stock at a certain price specified in your option grant. When you get
your options, the strike price is often the same as the shares' FMV (fair
market value).
Every employee stock option has an expiration date, which
means you have a certain amount of time to take action. You should always make
thoughtful decisions, regardless of whether you decide to use your stock
options. Here's how you handle the legal considerations that accompany employee
stock option management.
Stock Option Exercise: Legal Considerations
Knowing what kind of options you've got and the various
legal considerations associated with each before exercising stock options is
important.
Terms and Conditions
Carefully read the terms and conditions in your stock option
agreement before exercising your options. Comprehending the vesting schedule,
exercise window, and any company-imposed restrictions is imperative. There can
be legal ramifications if you don't follow these terms.
Let’s assume you received 1,000 stock options with a
one-year cliff and a four-year vesting term. It implies that options vest
progressively over the following three years, beginning after you have worked
for the organization for at least one year. If the award is for 10 years, then
that's the exercise window. You risk losing part or all of your options if you
quit the firm before the one-year cliff or don't exercise them within the given
window.
Tax Implications
Consider the potential tax consequences of your stock option
exercise. Option exercises may result in taxable events in some countries. You
should talk to a tax expert to know your tax responsibilities and how to reduce
them.
Imagine you have options that you can exercise at $20 per
share, but the market price is $50 per share when you opt to exercise it. There
is a taxable gain of $30 per share. Depending on your jurisdiction, this gain
may be liable to rates on ordinary income tax, capital gains tax, or both.
Securities Law Compliance
When a business goes public, its stock option exercise must
comply with securities rules, following all applicable rules and regulations to
stay out of legal issues. Careful adherence to the guidelines provided by
companies about compliance with these rules is essential. These laws regulate
the offer and sale of securities, including stock options. Failure to comply
with these laws may lead to civil or criminal penalties.
Suppose you work for a publicly traded company and decide to
exercise your stock options. In that case, you may need to comply with
securities laws, such as the Securities Act of 1933 and the Securities Exchange
Act of 1934.
Exercising Stock Options to Safeguard Employee Rights
While you can use your options from the moment they vest until
they expire, there are a few things to remember to safeguard employee rights.
Value of stock options
With the current price being more than the option's exercise
price, you can immediately sell some or all of your shares for a guaranteed
profit, which could be the only rational choice.
For example, your exercise rate is $5, and the stock rate is
$10. The immediate exercise and sale of your options will result in a profit of
$5 per share ($10 minus $5). Using the profit, you can avoid paying
out-of-pocket for the exercise expenditures (such as the exercise price, tax,
fees, etc.).
Liquidity
Instead of selling your private firm stock options on a
stock market for profit, you'll need to utilize your cash to exercise them.
Purchasing shares with funds that could never become liquid might also be
risky.
Financial standing
Exercising and selling your stock options immediately can
help you pay off debt, launch a business, buy a car, and other financial goals
if you need money now.
Additionally, a lot of financial experts suggest having a
diverse portfolio. So, to diversify your portfolio, you can sell your shares if
you own over 10-15% of your company's stock (not over 15 to 20% overall).
Legal Pitfalls to Consider and Avoid
Options grants motivate US startup workers, consultants, and
advisers, but many minor pitfalls can cause legal and tax concerns that are
difficult and expensive to correct.
Ignoring special clauses in Board approval
The Board of Directors of your firm must expressly authorize
the option grant in order for any unusual provisions, such as an accelerated
vesting period, to be included. In addition to referencing these provisions the
Board must adopt acceleration or other special terms, ideally alongside the
option grant.
In order to save time and avoid confusion, it is wise to
inform your legal counsel of any specific conditions in relation to their
option grants. Always Consult with your legal counsel before making any written
promises in order to avoid any mistakes or inconsistencies.
ISO violations
The US tax system favors incentive stock options (ISOs). ISO
treatment is available for several option grants to US taxpayer employees who
meet the rules.
Companies often make the mistake of not noticing the extra
rules that apply when the person receiving the ISO owns more than 10% of the
voting rights of all classes of business stock at option grants. Option grants
to 10% of owners qualify as ISOs when:
- During the grant, the exercise price is 110% of the FMV.
- The term should be under 5 years from the grant date.
The ISO rules also limit the number of choices that can be
made by ISOs based on their worth (as of the grant date) and their exercise
times in a given year. Companies can cross this threshold with significant or
early exercisable option awards.
Before getting option grants approved, make sure you and
your attorney have reviewed the basic requirements for ISO treatment and have
reviewed the option terms.
Disregarding US securities laws
Stock options are securities under US law. Thus, you must
follow state and federal securities regulations. Notify your legal counsel of
any suggested option grants, such as the option's states of residence, the
number of shares included in these grants, and the current FMV. They will
review federal and relevant state securities legislation requirements and guide
you before the Board approves them.
Safeguarding Your Future through Informed Stock Option Exercise
There isn't always a clear-cut way for employees to cash in
on their stock option exercise. Yet, it's also possible to have a good time
with it. To get the specifics of an option, you'll need to sign a contract with
the relevant business. You should read the conditions of your contract
carefully. The document will lay out the details, including the number of
options being granted and the duration of the vesting schedule. After all, you
worked diligently to acquire your vested options on stocks, and the thought of
using them to make more money should make you excited.
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