What is an Option?

If you’re reading this post, chances are that you are wondering about options. For example, you may be asking yourself: “What is an option? What is an option pool? How do you grant options? How do they vest? What does it mean to exercise an option?” All good questions. Let’s answer the first in this post and come back to the others later on.

An Option is a Security

In its most basic sense, an option is a security, like a share (but not identical). Options are securities which convert into, or can be exchanged for, other securities like shares. Another way to think of it is that an option grants the holder the right to acquire a share, subject to certain terms and conditions.

When dealing with options, this process of conversion or exchange is actually referred to as an “exercise”. There are some arcane reasons for the different names which we can skip. What you need to know is that options are securities, but they are not shares.

Securities Laws Apply

Why is that distinction relevant? Well, for one thing, knowing that an option is a security should make you ask another question: “Are options subject to securities legislation?” Yes, yes they are. Even options issued by private companies are subject to securities laws. So before you start issuing options to anyone, go call your lawyer (and put down that template you found online – chances are it won’t help you or save you any money).

Option Plans and Grant Documents

And knowing that they are not shares should tell you that options are not governed by a specific law (like the CBCA or the QBCA, for example). Options are instead governed by the option plan which created them and the option grant agreement or certificate which links them to an individual option holder.

An option plan is a document approved by a company’s board of directors which will typically set out the following basic parameters:

  • Who is eligible to hold options?
  • How many options can be issued under the plan?
  • Who decides who gets options and on what terms?
  • How are options exercised?
  • What happens is the company is sold?
  • What happens if the option holder is no longer involved with the company?

There’s more to it, naturally, but these are the generally speaking the most common issues which are addressed in option plans.

The grant agreement or certificate will usually state the following:

  • The name of the grantee
  • The number of options granted
  • Vesting terms and conditions
  • Exercise price
  • Date of grant and expiry

Grant documents also usually include a statement saying that the options granted are subject to the terms of the option plan.

Let the Experts Help

One of the great things about dealing with startups and emerging tech companies is that they are full of brilliant people. But sometimes, their bootstrapping habits are hard to kick and they try and do things on their own just to save a few bucks.

You wouldn’t issue shares on your own, would you? No.

So stick to the same rule with options, and let the experts help. Talk to your lawyer and your tax advisor before you do anything with options – there can be serious tax and other corporate consequences for both the company and the option holder if the plan and grants are not done correctly.

One Reply to “What is an Option?”

Leave a Reply

This site uses Akismet to reduce spam. Learn how your comment data is processed.