Stock options are an often-used employee incentive in the tech
sector. The options grant employees the right to buy shares
of the company at a predetermined price, allowing them to
participate in its future growth. There is no obligation for
employees to exercise their options. The options will often
vest over a period of time, rewarding employees for their
Stock options are a great compensation tool for a few
No cash outflow. For a start-up company, cash burn-rate
is a key item to manage. By granting stock options, you can
compensate your employees more without draining the bank
Motivates employees. You often hear the reason for this
in Westjet ads as "Because owners care." The goal
is to align an employee's interests with the company's.
The employee will be motivated to make the company more
profitable, as they will be better off financially as
Talent attraction. Tech companies that offer perks such
as stock options will be more attractive to talent.
Retention. Stock options plans encourage employees to
think long-term about the company, increasing retention.
Potential for cash inflow. Employees exercising their
stock options will actually be contributing cash to the company.
When employees exercise their options, they become shareholders.
They then have certain rights, depending on the type of
shares issued and the company bylaws.
This can include voting and attendance at annual general meetings,
receiving audited financial statements, and entitlement to
dividends. While you may trust your employees to not cause
shareholder disputes, what happens if they leave the company?
What happens if they sell their shares? A shareholders
agreement can be a very useful document to manage these types of
situations. Keep in mind that you are not just giving up a
percentage of the pie, you're giving up a portion of control
Determining the exercise price for the options can be tricky.
If the price is too high, employees won't be motivated as
they might see it as unattainable. If the price is too low,
the stock option's incentive power is reduced as the reward is
all but guaranteed. There are also tax rules that encourage
granting options with an exercise price that is at least equal to
the fair market value of the company's stock at the time of
issuance. If you're raising financing by issuing shares,
you might have a good idea of the company's value.
Otherwise, how do you really know how much the company is
worth in order to decide an appropriate option price?
Stock options also come with a fair amount of administrative
work. The stock option plan and agreements need to be created
and approved. Options granted, vested, exercised, cancelled and
expired all need to be tracked as well.
One thing that is often overlooked by employees receiving the
options is in order to realize any benefits of the options, they
have to pay the exercise price to receive the shares. When
the shares are not easily resalable, this can tie up their cash.
As such, employees are not as inclined to exercise options
unless they can see a potential payout via an IPO or private
So how does all this affect tax and financial statements at the
end of the day? The company's taxes are unaffected.
It gets no deduction for stock options granted, vested or
The employee gets taxed on the options, but in a somewhat
favourable manner. There is no taxable benefit when the
options are granted or vested. When the options are
exercised, there is no immediate tax to pay if the company is a
Canadian-controlled private corporation. The tax gets
deferred until the employee sells the shares. Generally speaking,
when shares purchased using stock options are sold, the employee
gets a deduction of half of the taxable benefit on the option (fair
value when exercised less exercise price), as long as:
a) the exercise price was equal to or greater than the fair
value of the stock when the option was granted, or
b) the employee holds the shares for at least two years if the
company is a Canadian-controlled private corporation.
For financial statement purposes, options that vest in the year
are reported as an expense. The value of the options is
estimated using mathematical models, such as Black-Scholes.
Financial statements must also disclose various details on
the stock options issued and outstanding.
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
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