STOCK OPTIONS in an EXECUTIVE EMPLOYMENT AGREEMENT

Experienced legal representation in reviewing, negotiating, drafting, improving executive employment agreements.

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Contact Neufeld Legal PC at 403-400-4092 / 905-616-8864 or Chris@NeufeldLegal.com

A stock option is a contract that provides the executive the right to buy a specific number of shares of the company's stock at a predetermined price, known as the strike price (a.k,a., grant price or exercise price), for a finite period of time. The optionality of the stock option is an essential characteristic, as it does not obligate the executive to acquire the shares; however, the corporation's aspiration is that its executives will be further incentivized by the value proposition that can be realized by its executives through their stock options and increasing the corporation's share price.

Stock options, as part of an executive employee's compensation package, is a powerful incentive for attracting top executive talent for several reasons, including:

• Alignment of Interests: They directly tie the executive's personal financial success to the company's long-term performance and stock price growth.

• Recruitment and Retention: Options are often used to attract top talent, especially at startups and growing companies that may not be able to offer high cash salaries. The vesting schedule incentivizes executives to stay with the company for the long term.

• Leverage: Options provide leverage, allowing the executive to control a significant amount of stock without the initial cost of buying the shares outright.

The key characteristics of stock options include:

• Type of Stock Options: There are two main types of stock options with different tax implications:

  • Incentive Stock Options (ISOs): Also known as "qualified" options, these are typically reserved for key employees and can offer preferential tax treatment. Gains may be taxed as long-term capital gains if certain holding periods are met..

  • Non-Qualified Stock Options (NSOs): These can be granted to a wider range of employees and are more common. The profit from exercising NSOs is generally taxed as ordinary income.

• Number of Shares: The agreement will specify the number of shares the executive has the right to purchase. Strike Price: This is the price per share at which the executive can buy the stock. It's usually set at the company's current stock price or a recent valuation on the date the options are granted.

• Vesting Schedule: This is a crucial element that determines when the executive can exercise their options. Vesting schedules are designed to retain executives and incentivize long-term performance. A common schedule is a four-year vesting period with a one-year "cliff," meaning the executive must remain with the company for at least one year to receive any of the options. After the cliff, the remaining options vest monthly, quarterly, or annually over the next three years.

• Expiration Date: The options have a time limit. A typical expiration period is 10 years from the grant date. The agreement will also detail what happens to vested and unvested options if the executive leaves the company (e.g., a 90-day window to exercise vested options).

Stock options can be a significant component of an executive's compensation, with corporate employers using the inclusion of stock options to attract and retain top executive talent, as they align the executive's interests with the long-term success of the corporation. Focal points for negotiation of stock options in the executive employment agreement, include questions and considerations such as the following:.

• What is the company's valuation? For private companies, understanding the most recent valuation and any established valuation methodology is critical.

• What percentage of the company do these options represent? Ask for a fully diluted share count to understand your true ownership stake.

• Can the vesting schedule be accelerated? It may be possible to negotiate for accelerated vesting under specific conditions, such as a "change in control" (e.g., a merger or acquisition) or being terminated "without cause."

• What is the post-termination exercise period? A longer period after leaving the company to exercise vested options is a significant benefit.

• Can you "early exercise" the options? This allows you to exercise options before they vest, which can have tax advantages.

• Is there a "golden parachute" or "clawback" provision? These provisions relate to what happens to your compensation and stock if there is a change in control or if the company can reclaim compensation under certain circumstances.

Executive employment agreements deserve considerable scrutiny and legal analysis given the financial implications emanating from the legal employment contract not being consistent with the negotiated specifics of one's intended employment arrangement. The differences in executive employment agreements may not be readily apparent to most people (often being very subtle and driven by legal terminology), yet the long-term financial implications to the executive employee can be staggering. As such, it is important to properly understand all the contractual aspects pertaining to an executive employment and their compensation.

For knowledgeable and experienced legal representation with respect to executive employment agreements, and other legal matters pertaining to one's employment as an executive employee, contact our law firm by email at Chris@NeufeldLegal.com or by telephone at 403-400-4092 / 905-616-8864.