The Abstract Truth

Advisory Agreements: Exercising Options

Posted by rbpasker on March 5, 2008

When one of my advisory board positions recently ended, I received notice from the CFO of the company that I had to exercise the options within 30 days after the termination date or lose them.

I had been an active advisor to the company, got paid zero in cash, and now I had to lay out a five figure check. Since the company had recently raised money, the valuation of the company had gone up, so the underlying shares were now worth more than they were when the grant was made. According to the IRS, I would have to pay capital gains tax on the difference between the option strike price and the current value of the underlying shares. This would amount to another five-figure check

This did not make me happy. Here I was, paying the company, not the other way around. And if the stock eventually became worthless, I had not only risked my own time (which I was fully prepared to do), but my money, too (which I was not prepared to do). To add insult to injury, I would also have to pay taxes on non-existent capital gains. If I am going to invest cash in a company, I want preferred stock, not common.

After a bit of research and consultation with my lawyer, I realized I had made a few mistakes.

First of all, at the time the options were granted by the board, I should have received a signed copy of the “Plan” under which my options were granted. That Plan lays out all of legalese that specifies what the circumstances are for granting, vesting and exercising the options. Had I been given a copy of the plan and read it, I might have noticed that the plan stated that the options had to be exercised after 30 days.

Second, I should have added a clause in the Advisory Agreement overriding the 30 day exercise-after-termination provision in the Plan. This would have allowed me to hold the options, cash-free and tax-free, until a liquidation event, before I would have to exercise them.

In the end, things worked out, but it required a lot of effort and caused a lot of angst.

In the next couple of days, I will be writing the CFOs of all the companies in which I have options, to make sure this doesn’t happen again.

And in the future, I will lay all this out during negotiations.

2 Responses to “Advisory Agreements: Exercising Options”

  1. Yikes – thanks for sharing your learning the hard way!

  2. Alex Suh said

    Absolutely correct Bob and it is amazing how many smart advisors don’t know this nor board members and VCs. In fact I am forwarding this to one of my boards who is going through this whole process now and does not understand either. Thanks.

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