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Options Without Strike Prices

Updated: Jun 6

Updated: June 4, 2024



“We granted some options – we just haven’t set the strike price yet.”

 

I thought of writing an article on the top ten errors made with options (and I may still do so). However, the above statement would be items one through five.

 

Saying you’ve granted options without a strike price is like saying, “I just got married – but I haven’t decided to whom.” It doesn’t make any sense. This misunderstanding can also cause a huge problem. In this article, I’ll first explain why it is not possible to grant options without exercise prices. I’ll then discuss the problems “granting options without strike prices” creates and provide some solutions.

 

To understand this issue, we need to use proper terminology. Many professionals use the terms award, grant, and issue interchangeably and incorrectly. The bolded sections below are abbreviated definitions from the Financial Accounting Standards Board’s (FASB) Accounting Standards Codification (ASC).

 

Grant Date: The date at which a grantor and a grantee reach a mutual understanding of the key terms and conditions of a share-based payment award.

  

Award: The collective noun for multiple instruments with the same terms and conditions granted at the same time either to a single grantee or to a group of grantees.

 

Issuance: An equity instrument is issued when the issuing entity receives the agreed-upon consideration. The grant of stock options or other equity instruments subject to vesting conditions is not considered to be an issuance.

 

These definitions get confusing, especially when the verb forms of the above nouns are used. For example, the FASB refers to “granting awards” and also “awarding to grantees.” Elsewhere they mention “offering to issue options.” So one can be forgiven for confusing these terms. But one term they should definitely not be confused with is “Promised.”

 

Promised: NA

 

This term is not defined by the FASB, but it’s what companies have done when they tell us they’ve granted options without strike prices. They’ve promised certain individuals (usually new employees via an employment agreement) a certain number of options. That’s not a grant, award, or issuance.

 

This is not just semantics. Here’s the problem: ABC Corp hired Jane Doe in February and promised her 100,000 options. They finally grant the options in June; but between February and June, ABC Corp raised a Series C round, and the value of its common stock jumped 3x. To avoid negative US tax consequences, the strike price of the options will need to be equal to or greater than the current value of the common stock.

 

In granting Jane’s options, ABC Corp is not allowed to backdate the strike price to the value when Jane was promised the options. Even though Jane was told the stock price was $0.20 when he joined, she’s now told her strike price will be $0.60 – and she’s pretty miffed!

 

There are a few different ways (all costly) to address this problem, but the best way is to avoid it in the first place. If a company maintains an active valuation, it can immediately grant options to new hires and not just promise them.

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