Stock Option Exercise Checklist

Stock Option Exercise ChecklistCongratulations, you’ve gotten your company off the ground.  You’ve incorporated, issued founder shares and filed 83(b) elections, adopted a stock option plan, granted stock options, and been working on your business for a while.  Now an employee who has been with you since the start wants to exercise a stock option that has vested in part.  What do you do?

Recommended Steps

I recommend that you take the following steps as you process each option exercise:

  • Review the stock option exercise notice; confirm that it is completed correctly and executed by optionee.
  • Make sure that you have all of the optionee’s original stock option paperwork signed and in the files (meaning, the notice of grant of stock option or stock option agreement).
  • Confirm that option was approved by the Board in minutes and/or a Board consent.
  • Confirm that your Rule 701 math was correct, and that you are operating within Rule 701’s limitations and conditions.
  • Was the optionee terminated and in connection therewith did the optionee execute a release of all claims?  If so, did the release terminate the stock option?
  • Confirm the tax status of the option being exercised—nonqualified stock option (NQO) or statutory (incentive) stock options (ISO)?  Is it in part an ISO and in part an NQO?
  • Make sure the optionee is only exercising with respect to vested options or options that are not vested but immediately exercisable.
  • Confirm Blue Sky securities law compliance. (In which state does the optionee reside? Are securities filings required?)
  • Does the Company have a repurchase option with respect to the shares?  Will the Company exercise its repurchase option?
  • Determine whether the Board of Directors needs to make a new determination of the fair market value of the shares to determine the tax withholding or ISO adjustment amount.
  • Calculate the tax withholding (including but not limited to federal income and federal employment) if the option is an NQO (if the option is an ISO, make sure employee understands AMT tax consequences and be sure to send notification of ISO gain to employee and IRS).
  • Make sure to obtain from the exercising optionee the strike price plus the tax withholding, if tax withholding is required.
  • Consider providing the optionee with disclosure of some of the material risks of buying the securities.  A bullet point list of risk factors, financial statements, for example.
  • Have Company counsel prepare a stock certificate and stock certificate receipt.
  • Update the Company’s capitalization table.
  • Make sure payroll is aware of the exercise and properly reports the exercise on wage statements/Forms W-2, or ISO adjustment notification.

Conclusion

Don’t rush through this process and miss an important step!

About Joe Wallin

Joe Wallin focuses on emerging, high growth, and startup companies. Joe frequently represents companies in angel and venture financings, mergers and acquisitions, and other significant business transactions. Joe also represents investors in U.S. businesses, and provides general counsel services for companies from startup to post-public.
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