Can I reprice stock options if a subsequent 409A valuation is lower than the exercise price?
Takeaway: Yes, you can reprice underwater options but doing so can be complicated and has material tax consequences so you should involve competent legal counsel to help with the process.
As a startup grows and evolves, so too must its compensation and incentive strategies. One challenge startups sometimes face is dealing with underwater stock options, which can have a profound impact on employee morale, retention, and motivation. This post will discuss why a startup might consider repricing underwater stock options and outline the process involved in doing so.
Understanding Underwater Stock Options
Stock options are a popular form of equity compensation, providing employees the right to purchase company shares at a predetermined price, known as the exercise or strike price. If the company's stock price increases above the strike price, employees can exercise their options and profit from the difference. However, when the company's stock price falls below the strike price, these options become "underwater," rendering them effectively worthless.
Why Reprice Underwater Stock Options?
Employee Retention and Morale: Underwater stock options can be demoralizing for employees, as they no longer represent a potential financial gain. Repricing these options can help restore the perceived value of the equity component of employee compensation packages and improve morale, making it more likely that key talent will stay with the company.
Aligning Interests: Repricing underwater options can help ensure that employees remain incentivized to contribute to the company's success. By restoring the potential financial upside, repricing can encourage employees to focus on driving the company's stock price higher.
Attracting New Talent: Startups must compete for top talent, and a competitive compensation package is crucial. Repricing underwater stock options can make the company more attractive to prospective employees by signaling a commitment to employee equity and long-term growth.
The Repricing Process
Evaluate the Situation: Begin by assessing the extent of the problem. Determine how many options are underwater, the average degree to which they are underwater, and how many employees are affected. This information will help inform the decision to reprice and the most appropriate repricing strategy.
Board Approval: Repricing stock options typically requires approval from the company's board of directors. Present the board with a clear rationale for repricing, including the benefits and potential risks, as well as a proposed repricing strategy.
Methods of Repricing
There are several methods for repricing underwater stock options. The four primary methods are:
option exchange or repricing,
restricted stock exchange,
purchase of underwater options for cash, or
supplemental option grants.
Each method has its own advantages and disadvantages, and it's important to consider the specific needs of your company and its employees when choosing a repricing method.
Obtain Stockholder Approval (if required)
Depending on the company's governing documents and stock plan, stockholder approval may be necessary for repricing. In such cases, a clear and transparent communication strategy is essential to secure the necessary support from stockholders.
Implement the Repricing
Work with legal and financial advisors to ensure compliance with applicable regulations and securities laws during the repricing process. This may involve updating stock option agreements, amending the stock plan, and notifying relevant regulatory bodies.
Conclusion
Repricing underwater stock options can be a valuable strategy for startups looking to retain and motivate employees. By restoring the potential financial upside of equity compensation, repricing can help align employee interests with the long-term success of the company. However, it's essential to carefully consider the specific needs of your organization, choose the right repricing method, and follow the proper legal and regulatory procedures to ensure a successful repricing.