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Demystifying the Option Agreement

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Abad Mian   January 12, 2017

Your Stock Option Agreement. If you work at a startup, you’ve probably got one. It lays out what you can and can’t do with your stock options, which happens to be a very important component of your compensation. But do you understand how an Option Agreement really works? Luckily, EquityZen is here to help.

First of all - what document are we even discussing? Startups can use a lot of different terms to refer to the same thing (see this Meditation from EquityZen on the equity documents you should always have on file). Today, we’ll be talking about the Stock Option Agreement, which may be titled as an Option Agreement, Stock Purchase Agreement or something similar. It may be included as part of your Stock Option Grant or Option Exercise Notice. Don’t worry too much about this however. What it basically boils down to is what options are you receiving, how do you exercise them, and what are the terms governing the shares once you’ve exercised?

Stock Option Grant

The first thing you’ll typically see in your Option Agreement is a reference to what options are subject to the Option Agreement, which are usually described in greater detail in your Grant. Your Grant is important for understanding your Option Agreement so we’ll discuss it briefly here. You should’ve received a copy shortly after you joined your company and it will include basic information on your options. Terms you’ll likely see include:

1. Type of Options - options come in 2 flavors - incentive stock options (“ISO’s”) and non-statutory stock options (“NSO’s”). If you’re an employee at a startup, you’ll almost certainly receive ISO’s, which offer favorable tax treatment. For a further look at the difference between ISOs and NSOs check our Meditation on Understanding Equity Compensation.
2. Date of Grant - this is the day the grant was formally issued to you.
3. Vesting Commencement Date - this is an important date that signifies when your options begin vesting. Vesting means your options become eligible to be exercised into actual company shares.
4. Expiration Date - this is the latest that you can exercise your options, typically 10 years after the Vesting Commencement Date. If you leave your company, you will usually have a shorter period (usually 30 to 60 days) to exercise, depending on the particular circumstances by which you left.
5. Vesting Schedule - this schedule determines when the options become yours to exercise. Until you vest, you haven’t earned them yet.. The most common vesting schedule is 4 years with a 1 year cliff, which means that 1/4th of your options will vest after 1 year, and the remaining will vest at a rate of 1/48th per month over the next 3 years.
6. Exercise Price - this is the price per share you will need to pay to exercise your options.
7. Total Number of Shares Granted - this is the number of options you were granted; which are eligible to vest.

Method of Exercise and Payment

This section lays out the procedure by which you can exercise your options. Exercising typically involves delivering an Exercise Notice (which should be included as part of your Stock Option Grant or Option Agreement documents), stating the number of options you wish to exercise and the method of paying for them.

Payment can typically be made by check or wire. If you are exercising as part of a sale, some companies may also allow for a same-day exercise, where a portion of the sale price is used to pay the exercise price.

End of Employment

This section explains how long you have to exercise your options if you leave your company. In the event of death or disability you or your survivors will typically have 6-12 months to exercise. If you voluntarily leave or are terminated not for cause (i.e. laid off), you will normally have 90 days.

Transfer Restrictions

This is one of the most important sections of your Option Agreement, especially if you ever choose to sell your shares. Transfer restrictions spell out whether, and how, you can sell your shares. Liquidity is crucial as many companies are taking increasingly longer to exit. You might want to plan for life events, such as paying off school debt or buying your first home. You may not be able to wait the 10-12 years it sometimes takes a company to exit, in order to plan your life. Additionally, having your wealth concentrated in the illiquid stock of a single company may not be the most prudent approach to wealth management. Being able to sell your shares is important, and understanding the rules that apply is crucial. There are two important types of transfer restrictions you may find in your Option Agreement.

The first is a Right of First Refusal or “ROFR”, which you will find in almost any Option Agreement. A ROFR is the Company’s right to purchase some or all of the shares you were planning to sell rather than allowing you to sell to a proposed buyer. From your perspective, this typically leads to the exact same financial outcome as selling to the original buyer you identified. The company is effectively saying, “Hey Susan, don’t sell your shares to Mike. We’ll buy them from you on the same terms.” A company typically has 30 days to decide whether to exercise its ROFR.

The second primary type of restriction is requiring board or company approval prior to a sale. This is less common than a ROFR, but seen with regularity. Under a board or company approval restriction, the company or its board have the final say on whether to approve or deny a transfer. It’s important to know that this type of restriction is in place before you start at a company, because it's much harder to sell your shares with this restriction in place.

One final restriction you may see is a mandatory lockup period, which is standard. This only applies if your company goes public and will restrict you from selling for a period of up to 180 days after the date of the company’s initial public offering or “IPO”.

Legal Opinions and Transfer Fees

Two more items to look out for in your Option Agreement or Exercise Notice are provisions requiring a legal opinion or payment of a transfer fee for a sale. Legal opinions will typically state that a transfer of your shares do not violate securities laws and can cost between $1,000 to $2,000. Transfer fees are a processing fee paid to your Company and can run between $1,000 to $3,000. Not all companies require a legal opinion or transfer fee and many require neither. However, it’s important to keep transfer costs in mind when contemplating a sale.


That’s a lot to dig into, but it’s crucial that you understand what’s in your stock option agreement before you make a major decision like choosing to exercise your options or sell. And before you leave, why don’t you check out some related Meditations from EquityZen:

Note: This column does not create an attorney-client relationship and is not intended as legal or tax advice. For an analysis of your particular legal situation, please contact a qualified attorney in your jurisdiction. For an analysis of your particular tax situation, please contact a qualified tax expert.

Shareholder's Playbook: What to Know About Selling Your Shares


Sharmila Achari   February 04, 2016

So you’re working at the pre-IPO company of your dreams….but you need some immediate liquidity. You’ve heard of platforms like EquityZen that help private company shareholders get liquidity for their shares, and you want to understand more about how the process works. Then this is the blog post for you!

It’s All About the Documents, Baby

The first step is understanding the documents related to your shares. For anyone looking to sell their shares, it is very important to understand the rights that the issuing company has with respect to those shares and what steps are necessary before the shares can be officially transferred.

Here is a short list of the most common documents you will encounter as a shareholder and what each document means (a more detailed list can be found here https://equityzen.com/blog/key-equity-documents-to-keep-on-file/): 

Option Documents
  • Stock Option Grant Agreement: This document sets out: (a) the number of options being granted to the employee, (b) the type of options (incentive stock options (ISOs) or non-qualified stock options (NSOs), (c) the exercise price, and (d) the vesting schedule for these options.  
  • Stock Option Plan: This is the governing document that describes the terms and conditions of your grant and is the same for each optionee. This document often contains the restrictions around selling or transferring your shares.
  • Notice of Stock Option Grant: A one page document describing the material terms of the stock option grant (It is not always included). 
Option Exercise and Stock Purchase Documents
  • Notice of Exercise: This document is filled out when you are ready to convert vested stock options into shares of the company (a.k.a. “exercise” the options). This document represents proof that you have exercised a specific number of options and shows the exercise price.
  • Stockholders Agreement: The governing document that contains the terms and conditions for owning shares in the company. Importantly, this document often contains the restrictions around selling/transferring shares in the company. The Stockholders Agreement will often set forth whether the company retains a “right of first refusal” (ROFR), the length of the ROFR period, and any other conditions that must be met before the company will permit the share transfer.
  • Confirmation of Exercise: This document is often provided by the company to a shareholder once the exercise of options is complete and you are now a shareholder. 
  • Stock Certificate/Stock Ledger: This one might seem obvious, but the stock certificate is the document issued by the company that evidences legal ownership of shares. However, since many companies do not issue physical certificates, such companies also maintain an internal stock ledger, which lists the names of all stockholders and the number of shares owned.  

Company Documents
  • By-laws: By-laws set out the day-to-day rules for the company’s organization and governance. By-laws can be important for startup employees because many companies have started including provisions in the by-laws that can materially affect your rights as a shareholder. Such provisions include restrictions on transferring your shares and any requirements that must be met before you can do so.  
Knowledge of the documents involved is an important tool for you when looking to sell your shares. In order for a platform like EquityZen to assist, we will need to: (1) establish that you legally own your shares and (2) understand what restrictions are imposed by the company before you can sell those shares.  Understanding the distinctions and information in the documents above can allow you to more effectively provide us with the information that we need and help get your shares sold faster.

Who You Gonna Call? 

Now that you have all your paperwork in order, the question becomes who can help you find a buyer and guide you through the share transfer process. In recent years, several platforms (including EquityZen) have arisen to meet the needs of startup employees in need of liquidity.  There are a variety of options out there from traditional brokerages to platforms like EquityZen. When considering selling your shares, it is important that the firm conducts share transfers in a manner that complies with the company’s stated policies as well as applicable securities laws. Platforms may also differ based on their minimum transaction size, the fees involved, as well as the level of service and professionalism offered. 

What are the Transfer Restrictions?

One of the key questions that we help you figure out is: “What needs to happen before I can sell my shares?” By reviewing your option and share ownership paperwork, we can guide you through the steps involved in the share transfer process and manage your expectations around timing of the sale.  Here are some common transfer restrictions that may be applicable to your sale:

  • Right of First Refusal (ROFR): Most private companies retain a “right of first refusal” (ROFR) over shares, which means that if a shareholder seeks to sell shares to a third-party, the company has the right to buy those shares back from the seller at the same price and terms that the seller offered to the third-party. Typically, when a seller submits a Transfer Notice stating their intent to sell a certain number of shares, this starts the ROFR Period, during which the company can decide whether or not it wants to buy back the shares. Typically the ROFR period will last between 30-60 days. If the company does not respond to the request within the ROFR period, or if it states that it will “waive the ROFR,” then you can proceed with your sale. Alternatively, if the company decides to “exercise the ROFR” and buy the shares back from you, then you still get your money. It’s a win-win!
  • Board Approval: In addition to a ROFR, some companies require approval from the Board of Directors before they will permit you to sell your shares to a third-party.  This restriction is usually contained in the By-laws or the Stockholders Agreement, if it is required by your company. Transfers requiring Board approval will often take a longer to complete because Board of Directors meetings only occur once a month or once a quarter. 
  • Legal Opinion: Some companies will also require you to provide an independent legal opinion stating that the sale of your shares will not violate any state or federal securities laws. If you don’t have an attorney you trust, a secondary marketplace can usually provide you a referral to an attorney who can provide this opinion for you. 
  • Transfer Fee: Some companies may require you to pay a transfer fee at the time that you sell your shares. This requirement is usually contained in the By-laws or Stockholders Agreement. 

So…What Will this Cost Me?

The total cost to complete a share transfer will depend on: (1) your company’s restrictions and (2) which secondary marketplace you use to complete the transaction. Typically, the secondary marketplace will not charge you to review your documents or list your shares for sale. If you complete a transaction through the marketplace, then the marketplace will charge you a fee based on a percentage of your sale price (usually 5%-10%). Additional costs may be incurred on account of a transfer fee charged by the company (typically between $1,000-$5,000) and a lawyer fee to prepare a legal opinion (typically between $1,000-$2,000).  

To Sum it All Up

While selling private shares is more complicated than selling publicly-traded shares, it is by no means impossible. Understanding the rights and restrictions attached to your private shares will help you considerably in determining whether you can sell your shares and what price you can command. In addition, partnering with the right secondary marketplace can be an invaluable resource in securing company approval and making the share transfer process as smooth and hassle-free as possible. 
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