Stock & Option Q & A
By Peter Kelman, Esq.
column appeared in substantially the same form in the Boston Software
News, September, 2000.
What is a stock option?
Many technology companies offer employees options in the company's
stock. An option is different from the stock itself. An option represents
your right, not obligation (that's why it's an "option"),
to acquire the stock of the company at a pre-determined price. A stock
option is a contract between you and the company that allows you to
buy a certain number of shares of the company's stock at a fixed price,
as determined by the board of directors.
After the market downturn are options still a good deal? Should I
accept these options?
The recent downturn of the market points out a valuable, and previously
often-overlooked, aspect of stock options, namely that the value of
an option is speculative; it is not money in the bank. The value of
an option can only be calculated in the future, when you acquire company
stock at the option price ("exercise your option") and then,
most importantly, sell the stock. If the value of your company's stock
has risen since you acquired your option, and your selling price is
higher than your option price, you will make money. If the market
price has dropped, the value of your options has also decreased. The
bottom line is that while stock options have no downside, they are
vastly different from the feel of money you receive as salary. Beware
of accepting a high percentage of options in lieu of salary.
Am I taxed for this?
You pay no tax when you receive a stock option. Assuming that these
options are "Qualified" (sometimes called Incentive Stock
Options or "ISOs"), you also do not pay a tax when you exercise
your option (i.e. when you buy your company's stock). If you then
sell your stock either to the company or to another person, and receive
more money for the stock than you paid for the option, your gain will
be taxed. Under our current tax laws, if you hold the stock for one
year or more after exercising your option, your gain will be capital
gain, which is generally taxed at a lower rate than other income,
or ordinary income. However, typically holders of options exercise
their options and then sell the resulting stock in a simultaneous
transaction. If you do this, you spend no money, you merely receive
the excess value of your stock over the cost of the option. This excess
value is treated as ordinary income and is taxed at conventional rates.
are concerned about the tax consequences of this transaction, please
do not rely on this brief explanation. Seek the advice of an accountant,
lawyer, or some other financial professional.
Will I have a voice in running the company?
By state law, as an option holder, you have no special rights in the
governance of the company. You are not a shareholder. A shareholder
votes to elect the company's board of directors and gets to vote on
certain other transactions. An optionholder does not have these rights.
My company has announced that it is going public. I have been instructed
not to mention this to anyone, that we are in the "quiet period."
What does this mean?
Going public is a complicated process that consists of many steps
that must take place before a company can sell its stock on a public
exchange. Part of the quid pro quo of going public is that for the
public to make an informed investing decision about whether to buy
a company's stock, that company must fully make available certain
information about itself. The Securities and Exchange Commission (SEC)
watches these things very carefully and will penalize a company if
it finds that the company attempted to sell stock without making full
disclosure. Companies advise employees and other "insiders"
not to discuss the fact that the company is going public, in case
such a discussion is construed as an attempt to sell the company's
stock without going through the required process of formal disclosure.
While it may seem remote to you, "gun jumping" or illegally
stimulating interest in a stock, can sink a company's efforts to go
My company will soon have an IPO. Will I get rich? Can I book my next
vacation to the Cayman Islands instead of George's Island?
An IPO (or Initial Public Offering) is an event principally intended
to raise money for a company. It is a process whereby a company discloses
information about itself to the public in the hope that the public
will invest in the company. Thus it "goes public" in an
effort to raise funds. By the law of large numbers, the company hopes
that a large number of small investors will provide it with more money
than a small number of large investors (banks and other financial
institutions). Notice that the equation omits you, the employee. In
other words, despite all the talk around the water cooler, a company
does not undergo an IPO for the direct benefit of its employees. However,
if the company's stock does well, you may indeed profit by its good
fortune. Thus the answer to your question is "It all depends."
Will I find out if I am rich the day we go public?
No. If you own either stock or options in your company, the chances
are that you have signed a document in which you agreed to certain
restrictions if your company went public. Some of these restrictions
are called "lock up" provisions. These restrictions affect
your ability to sell stock in your company. Investors do not want
to invest in a company, only to have the people who built the company
quickly cash out and depart the company. Most underwriters (the bankers
who take a company public) require that employees agree to hold their
stock in the company anywhere from six months to two years before
they can sell their shares. This assures investors that key employees
will not leave when the company goes public. Until your restrictions
lapse, and you can compare the price of your company's stock with
your cost of the stock, you won't know whether you have made money
on your stock.
With all these restrictions and uncertainties how am I better off
if my company goes public? How do I benefit?
The chances are that you are better off as a shareholder of a publicly
traded company as opposed to being a shareholder of a privately held
company. The major benefit you receive when your company goes public
is that there will be a ready market in which you can sell your stock
when you want to. Furthermore, if and when you sell your stock, you
will have a good idea how much your stock is worth. If you want to
know the value of a share of publicly traded stock, just check the
newspaper. But if you want to discover the value of share of stock
in a closely held company, there may be no place to turn. Typically
stock in a closely held company is valued by the company's board of
directors and they have a good deal of discretion in setting the valuation.
Even if you know the value of stock in a closely held company, another
hurdle to overcome before you can sell (or "liquidate")
your stock, is that you must find a buyer. Publicly traded stock generally
has a ready buyer, the anonymous public. Closely held stock, generally
has only one buyer, the company itself. If the company doesn't buy
your stock, then chances are no one will. Thus, while publicly traded
stock does not guarantee that you will be rich, it does mean that,
should you decide to sell your stock, you will be able to sell it
and you will get a fair price for it. Whether you actually make a
profit on the transaction depends, of course, on the per share price
being more than what you paid for each share when you exercised your
The questions and answers presented in this column vastly oversimplify
what can be highly complex issues of law. The point of this column
is not to provide definitive legal advice on specific topics, but
rather to sensitize readers to general legal issues described from
the 10,000 foot perspective. In no way is this column intended to
substitute for advice one would receive from an experienced practitioner
on a particular issue.
Peter Kelman, 2000. All rights reserved.