It is very common for a company to hire an employee on a specific date and in the employee’s offer letter state that “subject to board of directors approval, the employee will be granted a stock option” to acquire a certain number of shares, “with an exercise price equal to the fair market value of the company’s stock on the date of grant.”
What happens if the stock rises in value between the hire date and the grant date?
The option must be priced at the fair market value on the grant date–meaning, the date the board of directors grants the options, in order to avoid potentially adverse tax consequences to the optionee under Section 409A of the Internal Revenue Code. The hire date is not the relevant date for avoiding potential Section 409A tax problems.
For most private companies the risk of the fair market value of their stock increasing between a hire date and the next board meeting is not too great of a concern, but it can happen. What is recommended? Managing new hire expectations with regard to the timing of the grant. Among other things, include the language above in your offer letters–“subject to board of director’s approval, …. with an exercise price equal to the fair market value of the company’s common stock on the date of grant.”