ABC to the SOP - Part 1/2

If you are new to the Startup world these 3 letters - SOP - probably mean nothing, but you will start to see them everywhere, mainly listed in job descriptions as part of a compensation package.

So, let’s start with the basics. What are SOP? SOP are Stock Option Plans.?

The correct form, however, is ESOP - Employee Stock Option Plans, as it’s an equity compensation given by a company to employees. It may be broadened to include other key personnel such as officers, directors, advisors, consultants and other individuals expected to provide significant services to the company.

In short, a stock option is a right, not an obligation, that a company grants an employee to purchase a specific number of shares of its stock at a set price during a specified period.?

Please note that stock options are not actual shares of stock and you are not required to exercise, that is why they are called options. Also, SOP are very common in the US, but not in Europe, so there might be a lack of integration with local legal requirements. That is why you should contact a qualified professional advisor, like a lawyer or an accountant, before exercising in order to avoid being wrongly taxed.

Another thing that you need to know is that there are two types of SOP. Again this is more related to the US reality, but it’s always good to know:

• Incentive Stock Option (ISO) - qualifies for special tax treatment under the US Internal Revenue Code if certain requirements and holding periods are met. ISO’s are usually granted to US employees.
• Non-qualified Stock Option (NSO) - does not qualify for special favourable tax treatment under the US Internal Revenue Code.

Startups include SOP in the compensation package as a way of retention, on one hand they promise you high earnings in the future, on the other hand you can contribute actively to the company growth. In the end you and the company both win.

In order to better understand everything, we need to start with the basics:

• Grant Date - The date a company grants the options to the employee . It’s usually the start date of the employee at the company.
• Cliff - The period of time that has to elapse before the employee gets any of the vested options. Most common vesting schedules define that 25% of the options vest after the first 12 months.
• Vesting Schedule - The date when the employee becomes eligible to exercise a specific number of options. Considering the common standard of a four year vesting, after the cliff (that vests 12/48), 1/48th shall vest each month for 3 years. The difference for the cliff period is that vesting starts to occur on a monthly basis, with the pro-rata amount of SOP being vested each month.
• Exercise Price - The price at which the employee is eligible to purchase shares, once options are vested. This is usually the FMV (Fair Market Value) of the company’s commonsStock according to a 409 valuation or, if the company is listed in the stock exchange then it’s the market value defined when SOP are assigned. This is the discount price that an employee can convert their SOP's into company shares, after vesting.
• Expiration - The date after which the employee can no longer exercise the options. Most common is 10 years from the grant date if you continue working for the company, or 90 days counting from the day your agreement with the company is terminated.

Here is a very simple illustration of the process:

Although SOP’s have best practices in the market, each company may define its own terms. Therefore, you need to rely only on your company’s documents. This is because they reflect the correct process / information you must follow. Everything you need to know is available in these documents:

• Equity Incentive Plan - an agreement that explains the purpose of having options and the overall administration of the plan. This is a generic plan;
• Board of Directors Minutes - the effective document that grants the options to the employee, mainly the number of options, exercise price, vesting schedule, expiration date. Without these minutes, there is no grant;
• Stock Option Agreement - refers to a contract between the company and the employee. Both parties agree with the terms, conditions, and restrictions stipulated in the agreement.?

Hope you enjoyed this intro into SOP’s. Next time I will share an example ??

?? I help startups keep track of day-to-day operations by simplifying data flow within the company and between shareholders. This article is based on my experience working in Startup Operations. All feedback is welcome ??

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