Intro to US stock options

About the plan

The US stock options plan is a tax-efficient share option scheme used primarily by companies headquartered in the US. This plan gives employees the right to buy company shares at a predetermined price after a specified period. 

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Asset type

Stock options give their owners a right to buy company shares in the future for a fixed price (called exercise or strike price). The right to exercise options is typically subject to a vesting period. Once the employee exercises their options, they become the company’s shareholder.

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In the US, there are two types of stock options: Incentive Stock Options (ISOs) and Non-Qualified Stock Options (NSOs). Unlike NSOs, ISOs can qualify for special tax treatment if employees keep them for at least 1 year after exercise and 2 years after grant. 

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The US plan also typically gives companies the option to grant the so-called RSUs (Restricted Stock Units). RSUs give employees interest in the company's equity but have no tangible value until they’re vested. 

Best for

The US stock options plan is designed for US-based companies with a substantial number of US-based employees.

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Employee rights

Stock options holders don’t have any shareholder rights (like voting power or right to dividends) until exercise. After exercise, the options holder becomes the company’s common stock shareholder.

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Cap table effects

When options are granted, they don't immediately affect the cap table. But you should always include the options in the so-called fully diluted cap table, which assumes the exercise of all options and conversion of all convertible instruments into equity. You’ll need the fully diluted cap table for communication with investors and during the investment due diligence process.

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After exercise, the employees become company shareholders. As a result, the total number of outstanding shares rises and the existing shareholders are diluted.

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Payout

Stock options aren't liquid assets. Liquidity comes into play when options are exercised and the shares are sold, usually during the company's exit, on a secondary market (typically during Series B or later rounds) or in an IPO.

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Taxation

For employees, the difference between the stock's market value at exercise and the exercise price can be taxable. The specific tax treatment varies based on the type of options.

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Incentive stock options (ISOs) are only available to US tax residents. ISO owners receive preferential tax treatment because the IRS (Internal Revenue Services) treats ISO income as long-term capital gain.

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Non-qualified stock options (NSOs) can be granted to non-US tax residents. NSOs are taxed based on the tax rules in the recipient’s country of residence.

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But taxation laws vary across countries. Make sure to consult tax professionals to confirm the exact treatment in your location. If you need any help, schedule a call with our legal team here.

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Implementation steps

1. Fix company valuation: First, you need to get a company valuation (409a valuation). This can be done in-house but it’s advisable that companies outsource this. 
2. Authorize ESOP pool: Create and approve your stock options pool. 
3. Design the plan: Define plan parameters like eligibility, vesting, payout events etc. 
4. Draft and approve documents: You’ll need ESOP terms and award agreements.
5. Give awards: Sign award agreements with employees.
6. Inform your employees: Educate employees about the plan, its benefits and tax treatment
7. Manage the plan: Make new awards, manage leavers and keep track of vested assets. Also make sure you have an up-to-date valuation for every award round.

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Pros & Cons

Pros:

• Allows employees to become company shareholders (after exercise)
• Tax-efficient for ISO holders 
• Option to open secondary market

Cons:

• Valuation is needed at least once per year 
• Beneficial tax treatment limited to US-based team
• Can require substantial buy-in from employees on exercise

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