All right. So if you're going to be hiring employees, one of the issues that will come up fairly soon, stock options, this is a good way for you to incentivize your employees, to have an equity stake in the company. And it also serves as a way for you to have your employees, enjoy and participate in the future growth of your company. So in this lesson, we're going to go through some of the important concepts around stock options. We'll talk about the number of shares in an option pool. We'll talk about the type of option, that you may grant individuals in your company. We'll talk about exercise price, duration, the permissible forms of payment, vesting and transfer restrictions. So starting with the number of shares in an option pool. So when you're talking about stock options, what happens is, your startup establishes a collective pool of shares. And what you do is you grab options from this pool. Now, the limit on the number of shares that you can, or stock options that you can grant, is determined by the number of uncommitted shares that remain in that pool. So once you establish the collective pool, over time you will give options of shares from that pool. And the only limitation is whatever uncommitted shares are left in the pool. So this is not necessarily a science, it's more of an art than a science, but there are some kind of general rules around how you structure equity ownership in your company. So that you're available to have a future availability, for future rounds of funding. And the rule of thumb is essentially, you want to earmark about 20% of shares in your company, for employees and those who are providing, service to your company. And this 20% of shares not only include stock options, it also includes preferred stock, warranties and other securities. So you want to keep that at about 20%, so you want to think about that, when you have your collective pool of shares. And as you're granting options from that pool, think about keeping this at the 20% of the overall shares in the company. Talk about the types of stock options, the two primary types of stock options, one is what we call the incentive stock options. These are only available for employees of the company. And then you have, non qualified or non statutory stock options, and these can be given or issued to anyone. So if you're talking about your employees, it's going to be incentive stock options which have, some favorable tax treatment. Exercise price, now, when you grant a stock option, it must be granted at the fair market value of the stock at the time that you make the grant. There is the concept of a discounted stock option and this is where, you issued the option at a price lower than the fair market value. And by doing this, one there's a lot of accounting maneuvers you have to do, to achieve this discounted exercise price, but there's also serious tax implications for doing so. So if you're thinking about issuing a discounted stock option, make sure you talk to an experienced lawyer, so that you fully understand the tax implications of doing so. Now there is this, problem with getting into like the discounted exercise price. Sometimes people have in the past, people have tried to backdate [LAUGH] the grant date of their stock options in order to avoid some of the tax implications of the discounted pricing scheme. But doing maneuvers like that, backdating the grant date, that can get you in some very, very serious trouble including jail time. And so when you do grant a stock option, you want to make sure you have very detailed records of the fair market value at the time you made the grant, the date on which you made the grant. You want to make sure you have very detailed records of that, so you can avoid any allegations of securities fraud or tax fraud, because these can have some pretty serious criminal liability issues. Duration and payment, so the maximum duration for stock options under the law is 10 years. And you can structure your stock options for a duration that's less than that, but it can't exceed that. Also, in terms of duration, oftentimes whenever there's a stock option clause, that allows for termination of the option, or if the employee terminates his or her employment with your company. Oftentimes the stock option agreement, allows for the employee to have one, two or three months to exercise, their options if they choose to do so. Now, in terms of the payment methods for paying for your option, when you make the decision to exercise the option, you can pay by cash or cheques or any type of cash equivalent. You can pay by shares that you already own in the company, so vested shares that you already own in the company. You can issue a promissory note or in the event that the company is a public company, you can pay for the ability to exercise the option with proceeds from an immediate sale of stock in the public company. Let's talk about vesting. Now investing is the process by which shares become actionable, where the owner of the share actually owns the share and can transfer they can sell the share. Now, vesting allows your employees to participate in the financial upside of your company. And oftentimes when you issue equity to your employees, you want to have a vesting schedule. Typically it's a four year schedule with the one year cliff, and that means you have a block of stock that's invested, after working for the company for a year, one fourth of the stock vest after that one year cliff. That's what we call, the one year cliff. So one fourth of the stock vest after that year, and then the remaining three fourth of the stock vest over the course of the next 36 months, over the course of the next three years. And that can be once a year, it can be monthly, it can be semi annually, you can decide on that on how often the remaining shares vest. But that vesting schedule allows you to not only get your employees to participate in the financial upside of the company, but it also incentivizes your company, your employees to continue, dedicating service to the company. In addition to just a normal vesting schedule, you may also tie, vesting of shares to certain performance goals. If an employee hit certain milestones, they'll have a certain number of shares that vest. You can tie it to the years of service, if the employee stays with you every year, they get X number of shares that are vested. There are many ways that you can structure, this vesting schedule, but the vesting aspect of it, is what your employees are going to be most interested in. Then they transfer restrictions, now, the idea behind transfer restrictions is to make sure, that you maintain control over who owns stock in the company. And this is particularly important for early companies that aren't yet public, you want to make sure you know who owns, what stock in your company. And so what some transfer restrictions, allow the company to have the first right of refusal on vested or unvested shares. So if the owner of shares wants to sell, their stock options or otherwise transfer their interest in the stock options, what these transfer restrictions say is the company has the first right to purchase those shares vested or unvested from the employee. Now there's some drawbacks, to a company deciding to repurchase shares. So you just keep this in mind, if you're thinking about that as a way of restricting transfer of shares. The biggest one, and the most obvious one is the idea that, when you issue the shares, your issuing it at the fair market value of the stock. At the date of issuing the shares, at a later point in time, your company may have grown, you may have gotten more funding. You may have gotten higher evaluation, and so at the time of the repurchase, the fair market value of your stock may have increased. And so while you issue the stock at a lower price, if you're purchasing the stock back, you may be purchasing it back at a higher price. That's the kind of biggest and most obvious drawback to a stock option repurchase. And that's when you should keep in mind, when thinking about how, to structure some restrictions on transfer. So, to wrap up here, stock options, it's a preferable form of, securities or equity ownership for employee incentive program. Employees are going to want to have a way to participate, in the financial upside of the company. And this is a good way to do it, the issues that you want to think about, when you're trying to structure an employee incentive program around stock options. Are the number of shares that you want to have in the stock option pool, the type of shares that you want to have, the price, the duration for the options, the forms of payment, a vesting schedule. And any transfer restrictions, that you want to impose on the stock options that you're issuing. These are very complicated, issues, so as you're developing an employee sentiment program, you may want to consider, seeking the advice from a lawyer. A securities lawyer, who can help you think through all the implications of this type of securities related program.
