Common Option Grant Mistakes Seattle Startups Make

Related reading: The Most Common Option Grant Mistakes

1. Not actually granting options.

Offer letters, advisor agreements, and contractor agreements do not actually grant options. They merely promise them. If after executing one of those documents you don’t actually take the (more complicated) steps of actually granting the options (including with a Board consent), you will run into tax and cap table problems down the road.

2. Not providing grantees with the appropriate documentation.

There are very important terms in the actual equity plan documents that need to be delivered whenever an option is actually granted. If you fail to actually deliver the documentation, the company is exposed to claims by the grantees that the terms don’t apply. This has led to some very expensive problems for startups.

3. Not understanding how 409A valuations really work.

Options have to be issued with an exercise price at least equal to the “fair market value” of your stock. The most common and safest way to determinate that value, particularly after you’ve done at least a seed round, is with a 409A valuation. But those valuations don’t last forever. They go stale after 12 months, and sooner if there have been material changes to your company (such as closing a financing). Issuing options using “stale” valuations is a common startup mistake. Pricing options incorrectly can lead to tax penalties for both the recipients and the company

4. ISOs are only for employees.

We won’t get into the specific details of ISOs (Incentive Stock Options) versus NSOs/NQSOs (basically options that aren’t ISOs), but the important point here is only employees can get (more tax favorable) ISOs, and they have different restrictions. Startups often mess up by granting the wrong kinds of options.

5. Sloppy vesting schedule tracking and drafting.

Not everyone has the same vesting schedule. Drafting and tracking them, especially as your roster grows, is not as straight-forward as some people believe. Small mistakes in the wording of vesting schedule terms, or failure to update cap tables when people vest or are terminated, have led to many headaches and costly equity mistakes.

6. Promising people a percentage of the cap table, instead of a fixed number of shares.

If you promise someone “5% of the company”, is that 5% today, or 5% in 6 months, or 5% when the options are actually granted (see #1 above)? Is the percentage dilutable? What’s in the denominator (unused equity plan or not)? Never promise people a percentage in any contract or offer letter. Any contract should have the exact number of shares corresponding to whatever % was discussed, so there’s no ambiguity as to what the recipient is actually receiving. If you absolutely must promise a percentage, make sure an experienced attorney reviews it because they will have experienced the dozen ways in which sloppy drafting of % promises go wrong.