Stock options repricing: A guide for employers

Stock options are designed to motivate and reward employees by tying their success to the company’s growth. But when valuations drop, those options can quickly lose their appeal, leaving your team members feeling undervalued. That’s where stock option repricing comes in.

In this guide, we’ll walk you through why companies reprice options, what to consider before making changes, and how to approach the process in a way that supports both your people and your long-term goals.

So let’s jump straight in.

Why do companies reprice their stock options?

For many employees, it is not rare for stock options granted by their employers — especially early-stage startups — to be seen as less attractive compared to cold, hard cash.

This is particularly true in the tech sector, where down rounds are no longer the exception to the rule that they maybe were previously. Unsurprisingly, going from a wave of mega rounds to a drop or stagnancy in valuations has several consequences on the attractiveness of employee stock options, such as:

Fewer employees exercising their options

According to Carta, the number of employees exercising their options in the US has gone down. Based on the company’s recent research, the average exercise rate of “in the money” options — i.e., options whose current fair market value is higher than the strike price — has dropped by as much as 14% in recent years.

Most employees are now in a “wait and see” mode with respect to their options (unless they have been laid off and need to make an immediate decision).

More employees acquiring “underwater” grants

Some employees now have to pay more to buy their shares than the current fair market value. As a result, they hold what are often termed “underwater” or “out of the money” options.

For some employees — especially those deeply committed to the company’s long-term mission — this short-term uncertainty matters less. They’ll stay the course, weather challenges, and make the most of their options when conditions improve.

In reality though, most employees can easily feel demotivated by the lack of attractiveness of their equity package, which is why employers can be tempted to do a repricing of underwater stock options in an attempt to help retain and incentivize employees.

Is every team member with stock options eligible?

Most private companies will reprice the options of all their team members (and, in some cases, their contractors), although some may only consider repricing the options of their C-level executives.

However, it’s important to consider why you are repricing. If the goal is to try to keep motivation intact for those who will contribute to your company’s success, then all team members should be eligible.

It’s worth noting that most companies will not reprice the options of people who are no longer active, such as former employees within their post-termination exercise period.

What else should you consider when repricing stock options?

Compliance considerations can vary depending on where your company and your stock options holders are based. For example:

For US-based employers

For US companies with US employees, repricing may seem like a simple process of modifying an existing grant. But from a tax perspective, repricing an option comes down to making a new grant, and this has two consequences for incentive stock options (ISOs):

1. The 100k rule

To qualify for ISO treatment (and thus favorable tax treatment), the maximum fair market value of the stock (with respect to which ISOs at first become exercisable in any calendar year) should not be higher than $100,000.

When an ISO is repriced, this $100,000 limitation must be recalculated for the year of the repricing (including with respect to stock options that became exercisable and counted against the limit in a prior year). This leads to a higher probability of exceeding the $100,000 limitation and, therefore, the number of stock options being deemed NSO increases.

If you’re considering repricing large ISO grants, it’s worth investing some extra time to understand the impact based on the specific facts of the grant.

2. The holding period for long term capital gain tax treatment‍‍

To fully benefit from ISO status, one of the requirements is that the shares issued must be held for at least two years from the date the option is granted. Any new ISOs granted in exchange for the previously granted higher-priced ISOs will cause that two-year holding period to start again.

For non-US employers

In some countries, such as Australia, Belgium, Ireland, and Canada, taxation can (under certain circumstances) take place at the time of grant of the options. This depends on whether the options have been granted to an employee or a contractor, the specific terms of the option agreement, or the grantee’s taxation choice.

Since repricing an option amounts to a new grant, there could be tax consequences for the company and the service provider.

There can also be consequences when you have offered tax-favored instruments such as EMI, CSOP, or BSPCE. As a result, specific attention should be paid to the impact of tax-favored instruments such as ISO, EMI or BSPCE, or to international employees whose options could be taxed at grant.

A note on accounting

For most companies, a repricing of options will also result in an incremental accounting charge under accounting rules. The incremental charge for repriced stock options is generally fixed at the time of repricing, and typically equals the increase of the fair value (if any) of the repriced stock options over the original stock options.

In particular, later-stage companies should assess these accounting consequences.

Do shareholders need to be involved?

Shareholders do not necessarily need to be involved in the repricing process, but some documents (such as the equity plan, certificate of incorporation, or investor right agreement) may, in some rare cases, impose some restrictions and require shareholder approval.

In most private companies, only the board is typically involved in this process.

Does the initial grant documentation need to be amended?

Again, the initial grant document does not necessarily need to be amended, because repricing is normally in the interest of the grantee.

That said, there are cases where amendments are required, such as if your company decides to not only reduce the exercise price, but also keep the initial grant’s expiration date. Or if you decide to have a longer vesting schedule than the initial one.

There are also borderline cases when ISOs are repriced and lose (part of) their ISO status. In such cases, it may be prudent to obtain the grantee’s consent.

How do you communicate a stock option repricing?

‍Before carrying out a repricing, management should carefully explain the benefits to investors, as some of them may not see it as necessary or useful.

Ultimately grantees have to pay less if they exercise, meaning less incoming money for your company. While you should therefore make sure you communicate the repricing to your investors in advance, you should also stress the positive impact on employee morale and, in turn, productivity.

You should also communicate repricing sensitively to your employees. It may be good news for those whose options are being repriced, but it may be perceived as unfair by employees whose options are “in the money” and therefore not repriced.

In addition, some employees may not be aware that the fair market value of the company has gone down. In other words, the flip side of the coin is that it could raise doubts among your people as to the company’s ability to perform, thereby demotivating employees and having the opposite desired effect.

Regardless, repricing should be done in a transparent way. The format doesn’t matter, although the most common approach is to give a one-page notice that informs the grantees about the repricing, and the lower exercise price that now applies to their options.

How can Remote Equity help?

If your company has experienced a fair market value decrease, Remote Equity can help identify which grants are underwater (and would benefit from repricing). We also:

• Assist with preparing all the necessary legal documentation required for the repricing process
• Implement the repricing directly in your cap table
• Provide guidance and advice on the tax implications

Crucially, we ensure that the entire repricing process is compliant with local laws and regulations, which is especially important if you have international employees.

To learn more about how we can remove all the complexities and legal headaches, and make the repricing process painless, speak to one of our friendly experts today.