Employee Stock Option Plan | IRC 422 and 409A Ready Template

The plan is the umbrella. It states the number of shares reserved for issuance, names the class of people eligible for awards, appoints the administrator, and sets the default rules on vesting, exercise, forfeiture and change of control. The grant agreement sits underneath and does one job: it documents a specific award to a specific person, with a share number, an exercise price, a grant date and a vesting commencement date. A full package runs to three instruments: plan, notice of grant, exercise notice.

Two award types live inside the same plan. An incentive stock option qualifies under section 422, goes only to employees, and carries preferential tax treatment if the holder waits two years from grant and one year from exercise before selling. A nonstatutory stock option has none of those limits and reaches directors, advisors and contractors, at the cost of ordinary income and payroll withholding on the spread at exercise. Options are not restricted stock, which transfers shares outright subject to a repurchase right and is what founders take under a co-founder agreement with vesting and IP assignment.

Three bodies of law govern the same grant at once, and a document that satisfies one while ignoring the others is worthless. Section 422 comes first, with a checklist unforgiving in its detail. An employee stock option plan must state the aggregate number of shares issuable and the class of eligible employees, and stockholders must approve it within twelve months before or after board adoption. Options must be granted within ten years of the earlier of adoption or approval, cannot remain exercisable beyond ten years from grant, and cannot be priced below fair market value. Miss the stockholder approval window and every incentive stock option under the plan converts to a nonstatutory option, retroactively, for everyone.

Pricing is where section 409A takes over. An option struck below fair market value at grant is deferred compensation, and the holder faces immediate income inclusion plus an additional twenty percent tax and premium interest. Treasury Regulation section 1.409A-1(b)(5)(iv)(B) gives three routes to a presumption of reasonableness: an independent appraisal dated within twelve months of the grant, a binding formula applied to every transfer, and the illiquid start-up method open to companies under ten years old with no public market. A financing round kills that twelve month clock early.

Securities law is the third layer. Private companies rely on Rule 701 under the Securities Act of 1933, which exempts compensatory issuances under a written plan, subject to volume limits and an added disclosure duty once sales in any consecutive twelve month period pass ten million dollars. Recent SEC staff interpretations make that test forward looking: fail to deliver the disclosure and the exemption falls away for the entire offering. The statutory conditions appear in the Cornell Legal Information Institute edition of 26 U.S.C. 422. Corporate authority comes from section 157 of the Delaware General Corporation Law, and board procedure from your corporate bylaws drafted to the DGCL.

The first trigger is the first real hire. A company that promises "one percent" in an offer letter and adopts nothing has created an expectation with no share reserve behind it, and the repair six months later takes two consents and an awkward conversation about a strike price that has moved. The second is the seed round, since investors expect a pool sized before the money goes in and will ask for the plan and the grant history in diligence. Advisors and contractors are the third case: they cannot hold incentive stock options, so the plan has to authorize nonstatutory awards.

Refreshing the pool at a priced round is the fourth, and it needs a charter amendment under section 242 of the DGCL when the authorized share count no longer supports the enlarged reserve. Two edge cases deserve attention. Rule 701 covers a consultant only where that person is a natural person providing bona fide services unconnected to capital raising, which rules out finders and placement agents paid in equity. And a ten percent owner who wants incentive stock options needs a price at 110 percent of fair market value and a five year term, a detail missed when a founder becomes an optionee alongside an existing shareholder agreement with drag-along and buy-sell terms.

• The share reserve and pool mechanics fix the share number, describe how forfeited shares return to the pool, and record whether an evergreen increase applies. The reserve is tied to the authorized share count in the certificate of incorporation, so the plan cannot outgrow the charter.
• The eligibility and award type designation separates employees, who may receive incentive stock options, from directors, advisors and contractors, who may not. Every notice of grant carries an explicit label, since an award silent on its character is nonstatutory and the holder finds out at exercise.
• The exercise price clause anchors the strike to the board determined fair market value on the grant date and records the valuation relied on, with the 110 percent uplift that applies to a ten percent stockholder.
• The vesting schedule covers the four year term with a one year cliff, monthly vesting after it, and optional performance conditions. Acceleration is a choice between single and double trigger on a change of control, with "good reason" defined rather than assumed.
• The post-termination exercise window sets how long a departing holder may exercise, with separate treatment for death, disability and termination for cause. The default is three months for incentive stock options, and a longer window converts the award to nonstatutory treatment on the ninety first day.
• The transfer restrictions combine a bar on assignment, a company right of first refusal, drag-along coverage and a market standoff that survives an initial public offering. Executive awards sit beside an executive employment agreement covering 409A and 280G and are drafted to match it.

Delaware supplies the corporate authority for most venture backed plans. Section 157 of the DGCL governs rights and options, section 152 governs share issuance, and the two were aligned so a board may delegate grant making to an officer inside a resolution that caps the share number and fixes the pricing formula. Awards to directors and officers stay outside that delegation. Written consents under section 141(f) are the usual vehicle, and sections 204 and 205 offer a ratification path for defective grants.

California adds a filing that out of state companies forget. Under Corporations Code section 25102(o), a grant to a California recipient is exempt only if it qualifies under federal Rule 701, the plan complies with the option rules at 10 CCR sections 260.140.41, 260.140.45 and 260.140.46, and a notice of transaction reaches the Department of Financial Protection and Innovation within thirty days of the first issuance. California also runs its own alternative minimum tax under Revenue and Taxation Code section 17062, so the incentive stock option spread bites twice for residents.

New York matters at exit rather than at grant. A nonresident who worked in the state during the option period allocates the resulting compensation using a New York workday fraction across the grant to vest period, under Tax Law section 631(g) and 20 NYCRR section 132.24. Moving to a no-tax state before exercise does not erase the New York share of the spread.

Texas has no personal income tax, so the spread plays out with no state overlay. The live Texas issue is forfeiture. In Exxon Mobil Corp. v. Drennen, 452 S.W.3d 319 (Tex. 2014), the Supreme Court of Texas held that a forfeiture clause in a non-contributory incentive plan is not a covenant not to compete under Texas Business and Commerce Code section 15.50, and honored the plan's out of state choice of law.

You start with the state of incorporation and the entity type, which sets the corporate authority language and the consents attached at the end. The next screen asks for the share reserve and the authorized share count, and the form checks those numbers against each other before it lets you continue. You then choose which award types the plan permits, and the questionnaire adds or removes the section 422 provisions accordingly. The vesting block covers the schedule, the cliff and acceleration.

The grant layer comes last. You enter the recipient, the award type, the share number, the exercise price and the vesting commencement date, and the tool assembles the notice of grant, the agreement and the exercise notice as one package. Board and stockholder consents come with it, dated to sit before the grant date. Everything downloads in editable Word and signature ready PDF, alongside the wider set of business contract and incorporation templates.

The most common failure is sequencing. Grants get made at a board meeting that never produced a consent, on a date preceding stockholder approval, or against a valuation that expired when the company closed its Series A three months earlier. Each of those stays invisible until diligence, and each gets fixed retroactively at the company's expense. A close second is the offer letter promising a share number before the board has approved anything.

Silence on award type is the third: an agreement that never says whether the option is incentive or nonstatutory is nonstatutory, and the employee learns the difference on the day they exercise. Fourth, companies extend the post-termination window to twelve months as a kindness without telling the holder the award loses its incentive character after ninety days. Fifth, in California, nobody files the section 25102(o) notice on time. None of these errors announces itself when it is made, which is why the paperwork gets built in order rather than reconstructed later.