Incentivizing With Stock Options: What Your Startup Needs To Know About ISOs, NSOs And Other Parts Of The Alphabet Soup

One of the most common questions executives of emerging companies face when issuing stock options is what type of option to issue.

By Louis Lehot, business lawyer and partner at Foley & Lardner LLP in Silicon Valley, and formerly the founder of L2 Counsel, P.C. and the video blog series #askasiliconvalleylawyer

At formation stage, a startup should adopt an equity incentive plan to pay service providers with equity and position itself to be able to recruit and retain talent. The most ubiquitous form of equity compensation in the startup world is the stock option. At the point of formation when cash is scarce, startups use stock options as the currency of remuneration. If you don’t know the difference between the tools available, and most importantly, how they are taxed at the corporate and individual level, you will be leaving money on the table and fail to optimize value.

Louis Lehot
Louis Lehot
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  • NSOs may be given to any kind of service provider, whether or not an employee
  • ISOs must be exercised within three months after termination of employment
  • ISOs must be held for more than two years after grant.
  • The shares procured upon exercise of an ISO after exercise must be held for more than one year
  • ISOs must be exercised in 10 years of the grant date
  • The FMV of ISOs exercisable for the first time in a given year may not exceed $100,000 based on the FMV at the time of grant
  • Early exercise provisions can have an impact on the number of shares eligible for ISO treatment
  • ISOs are only transferable upon the death of the recipient
  • ISOs granted to shareholders must have an exercise price of at least 110% FMV and must be exercised in five years after the grant date
  • ISOs can only be granted by an entity which is taxed as a corporation (e.g., a “C” corp, and not an LLC, LLP, LP or S corp)
Louis Lehot
Louis Lehot

Louis Lehot is a partner and business lawyer with Foley & Lardner LLP, based in the firm’s Silicon Valley office. Follow on Twitter @lehotlouis

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