Founder's Guide to Issuing Stock Options and Securing Board Approval on Pulley

For founders, cap table management platforms, like Pulley, have become a standard part of the startup tool kit. These platforms minimize the potential for introducing mistakes into a startup’s cap table while also reducing the time needed to perform many essential tasks, such as issuing options. 

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One example where Pulley streamlines a process that can often take days is board approval and issuance of stock options - a critical component to most startup employee’s compensation. With a few clicks in Pulley, founders can issue options and submit them for board approval. 

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While these platforms do help with some of the more routine tasks, founders must recognize the inherent complexities and should exercise caution when customizing a standard process or procedure.
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Initiating the Option Issuance Process

When using Pulley, a founder can quickly and easily kickstart the stock option issuance process via the platform’s dashboard. However, founders must recognize that while the platform simplifies this process, it doesn't eliminate the need to understand the nuances surrounding issuing stock options, especially for the first few issuances.

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Recommended Best Practice: Understand your cap table before uploading any information to Pulley for the first time. Accurate record-keeping of current equity distribution is crucial to ensure your cap table is correct when first starting with Pulley, and for making informed decisions about new issuances as well as ongoing maintenance.

Creating the Stock Option Grant

The next step involves selecting the type of security, such as Options, for issuance. Pulley offers templates for ease, but creating your own requires a nuanced understanding of legal implications and financial impact.

Selecting the Type of Security: The first decision involves choosing the type of security to issue. Typically, this would be stock options, but it could also include other securities like restricted stock units (RSUs). 

The choice depends on your company's stage, goals, and financial strategy. Stock options are common in early-stage startups due to their flexibility and potential tax benefits for employees, but the decision should be made in consultation with financial advisors to align with your company’s long-term plans.

It's crucial to differentiate between Incentive Stock Options (ISOs) and Non-Qualified Stock Options (NSOs) to avoid common pitfalls.

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1. Incentive Stock Options (ISOs) are typically available only to employees and can offer tax benefits if certain conditions are met, such as holding the shares for a specified period post-exercise. They're ideal for retaining key employees due to potential long-term capital gains tax treatment. 

2. Non-Qualified Stock Options (NSOs) can be issued to both employees and external advisors, offering simpler taxation at ordinary income rates upon exercise. They are versatile but may result in higher immediate tax liabilities for the option holder.

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Choosing between ISOs and NSOs should be a strategic decision, informed by the company's growth plans and tax considerations. Consulting with financial advisors is essential to navigate this decision effectively, ensuring alignment with both the company's and employees' interests.

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Template Selection vs. Custom Creation: Pulley provides templates for stock option grants, which can be a starting point. However, depending on your company's specific needs and legal requirements, you might need to customize these templates.

Customization requires a deep understanding of legal terms and conditions, which might necessitate legal counsel. This step is crucial because the grant agreement sets the terms for exercising options, including price, vesting schedule, and expiration.

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Setting the Exercise Price: Determining the exercise price of the options is a key decision. This price should reflect the current fair market value (FMV) of your company's shares.

Getting this wrong can have significant tax implications for both the company and the option holder. Often, a 409A valuation (an independent appraisal of the fair market value) is required to set this price to ensure compliance with IRS regulations.

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Determining the Number of Shares: Deciding how many shares to include in the stock option grant involves balancing dilution with the incentive value to the employee. This decision should align with your company’s overall equity plan and consider the potential impact on your cap table.

It's a strategic decision that requires understanding how it affects current and future valuation, as well as employee motivation and retention.

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Incorporating Special Provisions: Depending on your company's policies or specific agreements with employees, you might need to include special provisions.

This could include clauses like acceleration upon change of control, early exercise options, or specific restrictions on the sale of shares post-exercise. Each of these provisions has legal and financial implications, and their inclusion should be carefully considered.

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Document Review and Compliance Check: Before finalizing the grant, it’s important to review the document thoroughly for compliance with securities law and tax regulations. This step often requires collaboration with legal counsel to ensure all aspects of the grant are legally sound and compliant with both federal and state laws.

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Recommended Best Practice: Align stock option grants with long-term business strategy and employee incentive plans. Each grant should be thoughtfully considered in terms of its impact on dilution and future fundraising.

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Customizing Option Terms

Customizing option terms, like enabling 'early exercise', demands strategic thinking. Enter the stakeholder's name and ensure their details are comprehensive in the Pulley system. The complexity here lies in the strategic decision-making that goes beyond just entering details.

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Recommended Best Practice: Consult with legal and financial advisors to understand the implications of different option terms. Custom terms should comply with legal requirements and reflect the company's strategic objectives.

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Defining Stakeholder Details

Input crucial information for the new option holder, such as email, relationship type, and compensation details. The number of shares and the issue date are key, but so is understanding the implications of these decisions on your company's future and the stakeholder's expectations.

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Recommended Best Practice: Maintain rigorous accuracy in entering stakeholder details. Errors can lead to legal complications and disgruntled employees or investors.

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Setting Vesting Schedules

Choose a vesting schedule aligning with the employee agreement. Specify the start date and grant type. This step is fraught with complexities related to employee retention and financial planning.

1. Choosing a Schedule: Select a vesting schedule aligning with your company's policies and employee agreements. Common schedules include cliff vesting and graded vesting. This decision impacts employee retention and motivation.

2. Vesting Start Date: Set the vesting start date, usually the employee's start date or the grant date. This date is crucial for calculating when the first tranche of options becomes exercisable.

3. Performance Conditions: If applicable, incorporate performance-based vesting conditions. These should be clear and measurable, aligning with your company's goals and the employee's role.

4. Early Exercise Options: Decide if you'll allow early exercise of options, which can have tax benefits for employees but also financial implications for the company.

5. Legal and Tax Compliance: Ensure the vesting schedule complies with legal and tax requirements. Irregular schedules or conditions might require additional legal scrutiny.

6. Communication: Clearly communicate the vesting terms to the employee. Transparency here avoids future misunderstandings and aligns expectations.

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Recommended Best Practice: Choose vesting schedules that motivate long-term commitment from employees while protecting the company's interests. Be clear and transparent about these schedules to avoid misunderstandings.

Review and Internal Approval

Assign administrators to review entered details. Engage an internal team for approval, but recognize that this process demands more than just a review—it needs strategic and legal consideration.

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Recommended Best Practice: Establish a thorough internal review process with multiple checkpoints. This ensures all grants are in line with company policies and equity plans.

Board Approval Process

Initiate the board approval process within Pulley. Achieve consensus among board members. The simplicity of the platform doesn’t diminish the complexities of board dynamics and legal intricacies.

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Recommended Best Practice: Prepare comprehensive documentation for board review, including the rationale for each grant. Effective communication with board members is key to smooth approval.

Finalizing the Option Grant

Request electronic signatures from authorized signatories in Pulley. Ensure all documentation is compliant, but also align it with your company’s strategic objectives.

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Recommended Best Practice: Ensure all legal and compliance boxes are checked before finalizing the grant. Use electronic signatures to expedite the process while maintaining a secure and verifiable record.

Audit and Record Maintenance

Maintain an audit trail for compliance and future reference. Documentation and tracking in Pulley should be thorough, reflecting an understanding of the broader financial and legal context.

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Recommended Best Practice: Regularly audit your equity management process and maintain meticulous records. This is crucial for legal compliance, future fundraising rounds, and potential exits.

Conclusion

Pulley streamlines the stock option issuance and board approval processes, enhancing operational efficiency and ensuring compliance. While it's an indispensable tool for founders, it's important to acknowledge that such platforms cannot fully simplify the inherent complexities involved in these processes.

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However, there's a silver lining. When provided with an Employee Stock Option Plan (ESOP), Pulley can automatically set up standard terms within its system. This means many of the strategic decisions discussed, including the choice between ISOs and NSOs, can be pre-configured into standard issuances.

This significantly simplifies the process for founders, allowing them to focus more on their company's growth and less on the administrative intricacies of stock options.

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Founders are encouraged to embrace tools like Pulley, not just for their ability to streamline administrative tasks, but also for their potential to demystify complex processes, making the journey of growing a startup a little less daunting.


Interested in optimizing your stock option issuance and board approval process? Explore how our platform can streamline your equity management. Let's simplify your journey together

Note: Our content is for general information purposes only. Levy does not provide legal, accounting, or certified expert advice. Consult a lawyer, CPA, or other professional for such services.