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What Is A Stock Option? – Securities



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If you’re reading this post, chances are that you are
wondering about options. For example, you may be asking
yourself: “What is an option? What is an option pool? How do
you grant options? How do they vest? What does it mean to exercise
an option?” All good questions. Let’s answer the first in
this post and come back to the others later on.

An Option is a Security

In its most basic sense, an option is a security, like a share
(but not identical). Options are securities which convert into, or can be
exchanged for, other securities like shares. Another way to think
of it is that an option grants the holder the right to acquire a
share, subject to certain terms and conditions.

When dealing with options, this process of conversion or
exchange is actually referred to as an “exercise”. There
are some arcane reasons for the different names which we can skip.
What you need to know is that options are securities, but
they are not shares.

Securities Laws Apply

Why is that distinction relevant? Well, for one thing, knowing
that an option is a security should make you ask another question:
“Are options subject to securities legislation?” Yes, yes
they are. Even options issued by private companies are subject to
securities laws. So before you start issuing
options to anyone, go call your lawyer (and put down that template
you found online – chances are it won’t help you or save you
any money).

Option Plans and Grant Documents

And knowing that they are not shares should tell you that
options are not governed by a specific law (like the CBCA, for example). Options are instead
governed by the option plan which created them and the option grant
agreement or certificate which links them to an individual option
holder.

An option plan is a document approved by a company’s board
of directors which will typically set out the following basic
parameters:

  • Who is eligible to hold options?

  • How many options can be issued under the plan?

  • Who decides who gets options and on what terms?

  • How are options exercised?

  • What happens is the company is sold?

  • What happens if the option holder is no longer involved with
    the company?

There’s more to it, naturally, but these are the generally
speaking the most common issues which are addressed in option
plans.

The grant agreement or certificate will usually state the
following:

  • The name of the grantee

  • The number of options granted

  • Vesting terms and conditions

  • Exercise price

  • Date of grant and expiry

Grant documents also usually include a statement saying that the
options granted are subject to the terms of the option plan.

Let the Experts Help

One of the great things about dealing with startups and emerging
tech companies is that they are full of brilliant people. But
sometimes, their bootstrapping habits are hard to kick and they try
and do things on their own just to save a few bucks.

You wouldn’t issue shares on your own, would you? No.

So stick to the same rule with options, and let the experts
help. Talk to your lawyer and your tax advisor before you do
anything with options – there can be serious tax and other
corporate consequences for both the company and the option holder
if the plan and grants are not done correctly.

The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.

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