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are securities that entitle but do not obligate their holders to purchase company securities in the future for a predetermined price or a price determined by a formula. Because they do not obligate the holder to purchase shares, they cannot be used to ensure future financing for a company. Even so, they are frequently used by growing companies to attract and retain qualified people, to obtain concessions on loans and to reward outstanding performance. Options are granted by a company’s board of directors. Shares that can be purchased through an option are referred to as the option shares. The purchase price for option shares is referred to as the exercise price or strike price. Options with exercise prices higher than the fair market value of the company’s shares are considered to be "out of the money." Options with exercise prices lower than the fair market value of the company's shares are considered to be "in the money." Option grants are usually for a fixed number of shares at a fixed price per share. Often, the option only becomes exercisable in the future or becomes exercisable as to progressively more shares as time passes. Exercise, or purchase of the shares, is effected by paying to the company the purchase price for the shares after the option becomes exercisable. For example, to attract and retain a key employee, a company’s board of directors might grant the prospect an option to purchase 40,000 shares of company common stock at an exercise price of $.10 per share. The employee’s right to purchase the option shares might be conditioned on his remaining employed by the company and might be staggered so that he would have to wait one year before purchasing the first 10,000 shares, with another 10,000 shares becoming available for purchase on the following three anniversaries. Venture capitalists sometimes bargain for options when they fund a company. They do so because options enable them to increase the upside potential of their investment without obligating them to purchase additional shares from the company. Options are sometimes used to provide investors with antidilution protection. They do this by giving the investor the right to purchase securities in the future at today’s price or another bargain price. Lenders sometimes request options, or warrants, in consideration of making a loan or granting an interest rate or term concession. Options are used frequently to attract new employees or to reward existing management personnel. Options provide an attractive incentive for employees because they give them the opportunity to share in the value created by a company’s growth. See: Equity Kickers, First Refusal Rights (Company), Golden Handcuffs, ISOs (Incentive Stock Options), Qualified Stock Option Plans, Warrants. |
