August 1, 2013. A startup may consider offering key individuals stock options and senior executives looking for additional value in a hiring package may consider stock options as an enticing business option. However, stock options are very risky. What if the startup fails? Stock options then become worthless.
First, the Company and the Employee should ensure the options are in writing and well documented. Often with startups (and even going concerns) the documentation is at the bottom the list of important things to be done. Frequently companies are focused on the activities that increase receivables and not what generates lawyer bills. For those companies that do properly document these options, the Stock Option Agreement is typically linked to a stock option plan and may be subject to an investor stock plan. These various agreements probably have a buy back provisions and may include a vesting schedule. If the employee is separated from the company for some reason the company may elect to buy back the stock at a set price that is advantageous to the company eliminating any profit the employee gained. For example, take a look at the illustrative attorney letter and Stock Option Grant Agreement available here and here.
It is important to follow up on the details and all referenced agreements that impact the Stock Option Agreement. Often these additional documents contain one or more legal conditions that could potentially make the stock options worthless. There is less risk in a large publicly traded company’s stock options with a history of profits. If you plan on issuing stock options be sure to document the transactions clearly or potentially face claims later and if you are taking stock options be sure to recognize the risks.