Stock options are typically a critical component of a private company’s ability to recruit, incentivize and retain key talent. Particularly for early-stage companies, rewarding equity packages can help make up for the gap between the cash compensation a startup can offer against the more significant cash compensation their larger competitors can afford to pay. However, when stock options have exercise prices that are higher than the fair market value of the underlying stock (i.e., when the options are “underwater”) they lose most, if not all, of their incentive and retentive value. And where there is a competitive market for talent, the lack of effective equity incentives may make the departure of key employees more likely. As a result, a company may determine that a repricing of underwater options is necessary to retain executives and other employees who are instrumental in the company’s future success.
While the term “repricing” can cover a variety of structures, private companies usually opt for a simple options-for-options approach in which the exercise price of underwater options is reduced to an exercise price equal to) the then-current fair market value of the underlying stock. While there are other repricing structures – options-for-restricted stock, options-for-restricted stock units, or event option-for-cash – in this alert, we focus solely on the options-for-options structure because it is the least administratively complicated, avoids undesirable tax consequences and preserves cash. Even so, there are number of business and legal considerations that a private company must balance as it evaluates whether and how to implement a repricing, including the (often surprising) consideration that the consent of option holders may be required, as discussed below.
