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Tyler Hollenbeck

At formation, founders often ask us for recommendations regarding terms and structure of their companies’ incentive stock option plans.  When making these recommendations to new companies, I generally advise that founders choose relatively “standard” and “straight-forward” terms, which have the dual benefit of keeping legal costs in check at formation and signaling to potential investors going forward that the company’s “house is in order.”  Although individual circumstances may dictate deviation, below are the high-level recommendations that I typically give regarding equity incentive plan structure:

  1. Size of Stock Option Pool.  Typical range is between 5% and 20% of the company’s fully diluted capitalization.
  2. Authority to Approve Grants:  In order to comply with IRS rules, and for other corporate governance reasons, only the company’s board of directors (or a designated committee of the board) should be authorized to approve options grants.
  3. Types of Awards.  For early-stage companies, I typically recommend only authorizing stock options (rather than restricted stock purchase rights, restricted stock grants, etc.), which keeps the equity incentive plan more streamlined and avoids a number of tax, accounting and corporate governance complications associated with restricted stock rights and grants.
  4. Types of Options.  I recommend having both Incentive Stock Options and Nonstatutory Stock Options available for grant under the plan, as this provides the company with maximum flexibility to incent new employees.  In general, Incentive Stock Options provide recipients certain tax benefits over Nonstatutory Stock Options.  However, in order to receive these benefits, the recipients of an Incentive Stock Option must comply with a variety of rules.
  5. Term of Option.  IRS rules require that options survive for no more than ten years in order to be treated as incentive stock options; accordingly, I generally recommend that all options expire if not exercised within ten years after grant.
  6. Early Exercise Feature.  I typically recommend against adding an early-exercise feature (which is only available for Nonstatutory Stock options), as there are a number of administrative complexities associated with early exercised options (e.g. 83(b) filings, escrow for unvested shares, etc.).  In addition, including an early exercise feature also has corporate governance implications, as holders of exercised options (i.e. shares) are entitled to significantly greater rights (e.g. voting rights, certain information rights, etc.) than holders of unexercised options to purchase shares.
  7. Vesting; Acceleration.  With early-stage companies, we generally see monthly vesting over four years with a one year cliff from the date of hire (rather than the date of grant). With respect to acceleration upon a change of control, although these provisions are favorable to employees, investors and potential acquirers generally dislike acceleration (as it adversely impacts post-closing employee incentives) and often force target companies to eliminate any acceleration prior to closing an acquisition transaction.  Accordingly, I generally recommend against including default acceleration in the option plan itself and instead granting the board latitude to provide for acceleration in specific grants to key employees, or to amend existing grants for all employees if and when an acquisition deal occurs.  This approach allows the company to maintain maximum flexibility in attracting investors and negotiating the terms of potential acquisitions, while also incenting key, sophisticated employees who demand acceleration protection.
  8. Post-Termination Exercise.  Again, because IRS rules require that options be exercisable for no more than ninety days following an employee or contractor’s termination of service (and no more than twelve months following death or disability), I typically recommend that option plans provide no longer than ninety days for post-termination exercise of any vested option (and no longer than twelve months for exercise following death or disability). In addition, I typically recommend that options terminate immediately upon an employee or contractor’s termination for cause in order to avoid a disgruntled former service provider becoming a stockholder of the company.
  9. Transferability of Options.  Non-transferability of options is not only required to comply with the federal securities law exemption under which most options are granted but is also advisable from the perspective of controlling a company’s stockholder base by preventing non-service providers from holdings options or becoming stockholders.
  10. Repurchase Right; Right of First Refusal. Again, in order to limit a company’s stockholder base to persons connected to the company, I generally recommend including (i) a company repurchase right (generally at fair market value, as determined by the board) over shares issued upon exercise of options in the event such stockholder’s service to the company terminates and (ii) a company a right of first refusal over transfers of shares issued upon exercise of options.