Introduction
Startup companies may offer equity awards as part of their compensation package. This is a way to attract and retain the best talent for the company. These equity awards can include Restricted Stock Awards, Stock Options, and Restricted Stock Units. Click below to jump to that section of the article:
Restricted Stock Awards
What is a Restricted Stock Award?
A Restricted Stock Award (RSA) represents common stock issued from the Stock Incentive Plan (SIP) and are typically granted to employees or other service providers in very early-stage companies. Once issued and paid for, the holder owns the shares outright. RSAs are usually subject to vesting conditions, meaning that certain time periods or milestones must be met in order to keep all of the shares. RSAs are considered restricted stock, meaning they cannot be freely traded or sold.
Why issue RSAs?
Companies may choose to issue RSAs over other equity awards for several reasons. Generally, they are issued by early companies when the fair market value (FMV) of their common stock is very low. This can be advantageous to the employee as the cost to own their shares is typically very low, and they may avoid significant tax burdens if they were to receive shares as compensation instead of purchasing the shares. Unlike stock options, RSAs do not have to be exercised and the long-term capital gains tax holding period starts when the shares are acquired.
Stock Option
What is a Stock Option?
A stock option is an equity award that grants the holder the right to purchase shares of the company's common stock at a fixed price. The holder is under no obligation to purchase the shares. Options are often granted to new hires as part of their compensation package.
Stock options are not shares, and you do not own anything unless you exercise, or purchase, your options. Typically, options are subject to vesting restrictions, and you may lose the chance to exercise your shares if you leave the company before the vesting period has completed.
There are two main types of options: Incentive Stock Options (ISO) and Non-Qualified Stock Options (NQO).
Grant Details
When an employee is granted options, they are given a contractual right to purchase shares in the company at a future date. When that happens, a Stock Option Agreement is created and signed by both parties (the company and the grantee). This agreement includes information such as your name, grant date, type of options granted (ISO or NQO), number of shares, grant price (the fixed purchase price, sometimes called the strike price or exercise price), and vesting information (see the section below for more information about vesting)
The screenshot below is an example of the grant details from an ISO Award Agreement. The details show us that the holder has been granted 12,000 shares of Common Stock with an exercise price of $0.07 per share. The grant was issued on 8/8/22, and the four-year time-based vesting schedule starts on 8/8/22.
Why issue Stock Options?
Stock options are commonly used by companies to attract and retain service providers. Companies may find managing and administering options to be easier. Option plans can also provide different tax treatment that may be advantageous to the company. If the FMV of the company is low, this can provide a way for their employees to become owners by taking advantage of the low cost to purchase.
Options provide some benefits to the holders as well. There is no financial obligation when options are granted, and some types of options can provide additional tax benefits when exercised. The price you pay to exercise does not change over time, even if the valuation of the company changes.
Restricted Stock Units
What is a Restricted Stock Unit?
Restricted Stock Units (RSU) are a type of equity award that promises the holder shares of common stock once certain conditions have been met. In addition to vesting restrictions, RSUs commonly have triggers, which is a certain event or milestone that has to be met. Once all applicable vesting and triggers have been met, the RSU will settle, and shares are issued to the holder.
RSUs are commonly issued as either single-trigger or double-trigger. A single-trigger RSU only requires one restriction to be met to settle, typically a time-based vesting schedule. Double-trigger RSUs will settle when two restrictions are met, such as a time-based vesting schedule and if the company has a successful exit event such as an IPO. Currently, Fidelity Private Shares supports double-trigger RSUs.
Why issue RSUs?
RSUs are more commonly issued by later-stage companies when the FMV is higher. If a company's FMV gets too high, option holders may not want to exercise due to the large financial burden. RSUs can provide a similar benefit by providing future equity without requiring the holder to purchase the shares. RSUs can be easier to manage as settlements are usually tied to an event like an IPO and do not require as much administration as other equity award types. RSUs do have a different tax treatment from options and RSAs depending on the vesting, triggers, and settlement details.
Vesting
Typically, equity awards include vesting restrictions, meaning that you do not get the full grant until certain conditions have been met. Awards are most commonly issued with time-based vesting schedules, and less commonly with milestone or event-based vesting. The vesting schedule outlines when and how many shares vest.
Stock options can only be exercised when the shares vest, although some companies may allow you early exercise your options (meaning you can exercise unvested shares). With an RSA, you keep your vested shares and unvested shares may be subject to repurchase if you leave the company before the award is fully vested.
Vesting Cliffs
Companies may opt to include a cliff as part of the vesting schedule. The cliff is a probationary time where no shares will vest until the cliff timeline has been met. Once met, the number of shares that would have vested during the cliff will typically vest, and then the grant will continue to vest based on the details of the vesting schedule. If a new hire's grant has a one-year cliff, this means they need to work for the company for a year until they can exercise any shares.
In the example below is a common vesting schedule. This is a four-year schedule with a one-year cliff. The shares will vest over a period of four years; however, no shares will vest until the one-year cliff has been met. After the one-year cliff is met, 25% of the shares will vest. The grant will then continue to vest monthly for three years.
Some companies may issue grants with milestone vesting schedules. The company will establish the requirements of each milestone (such as hitting sales targets), and the number of shares that will vest when met. These requirements could be things like meeting sales goals or company performance.
My Equity
Details of your grant can be found on the My Equity page. This page will have a chart showing the vesting for all of your grants, and a table showing details of each grant. Any exercises or other transactions will show here as well. Clicking the name of the grant will bring you to the document stored in the Data Room.
If you have more than one grant, the vesting chart will show each individual grant. Hover over the chart to see the detailed number of shares that have vested or will vest on a particular date.
FAQs
Am I required to exercise my options? How do I do so?
You are not obligated to ever exercise (or purchase) your options. If you choose to exercise, you will buy the vested shares at the set exercise price. Even if the company valuation (the Fair Market Value, or FMV) changes over time, your set exercise price will typically not change, and that is the price you will pay to exercise your vested shares.
There are many things to take into consideration when deciding to exercise such as: how is the company doing, can you afford the purchase price, and is it a good time to exercise? We recommend speaking with your tax and financial advisors when making these decisions.
When can I exercise my options?
You can only exercise your options if they've vested, unless your company offers Early Exercise, meaning you can exercise options at any time, regardless of whether they're vested. If you leave the company before those early exercised shares have vested, typically companies will have a right of first refusal where they may repurchase the unvested shares back from you.
Something else to keep in mind too, is that options usually expire after 10 years, or a shorter span of time if you leave the company. This means that if the options are not exercised (purchased) in the given timeframe, you will have to forfeit them.
What happens if I leave my company?
If you have an RSA, you keep the shares that have vested, and the company typically repurchases the unvested shares. With RSUs, generally you will retain any vested shares but may need to wait until all triggers have been met.
With Stock Options, any vested shares that you have exercised are yours after you leave the company. If you have early exercised any shares that have yet to vest, the company will most likely repurchase those unvested shares.
Upon termination, any unvested shares will return back to the company. Depending on the details of the company's Stock Incentive Plan, and the reason you leave the company, you will have a certain timeframe to exercise any of your vested shares, known as the Post Termination Exercise window, or PTE. For example, most companies give a 90 day or three-month PTE for voluntary or involuntary terminations. Terminations due to death or disability typically provide a longer PTE window between 12-18 months. If you are terminated with cause, there will most likely be no PTE and all shares may be forfeit upon termination. Your company may have different PTE periods that are described in the Stock Incentive Plan documents you will receive with your grant.
I'm ready to exercise my options. Now what?
There is a simple process to exercise your stock options in the platform. See this article for information on how to exercise your stock options.
Screenshots are for illustrative purposes only.
Fidelity does not provide legal or tax advice. The information herein is general in nature and should not be considered legal or tax advice. Consult an attorney or tax professional regarding your specific situation.
Fidelity Private Shares LLC provides cap table management and other administrative services to private companies and their equity compensation plans.
Fidelity Private Shares LLC
© 2024 FMR LLC. All rights reserved.
1094020.3.0
Comments
0 comments
Please sign in to leave a comment.