As equity prices have fallen, we have received requests from several of our portfolio companies for information and guidance about repricing stock options. To address this request, I hosted a webinar with two experts on options repricing. They offered detailed information on how to decide if repricing is warranted and, if so, what possible actions are available—with pros and cons for each approach.
Joining me were:
• Ali Murata, a partner in the Compensation & Benefits group at the law firm Cooley
• Kristin O’Hanlon, special counsel in Cooley’s Compensation & Benefits group
Finance and talent leaders from Norwest portfolio companies joined the conversation, posing many insightful questions.
I’ve summarized the conversation in a three-part blog series:
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- Deciding if options need to be repriced
- Understanding the alternative methods for repricing
- A guide to implementing the chosen approach
This is only a high-level summary of certain salient points discussed—deciding whether to reprice options and, if so, how to structure the repricing requires a detailed facts and circumstances analysis. This analysis should be done in close consultation with your legal, tax and accounting advisors.
First up, how to determine when the time is right for repricing.
Do Your Options Need to Be Repriced?
We all recognize the importance of stock options in attracting and keeping talent. So, when the market value of stock falls below the strike price of an option (a situation called “being underwater”), it’s a concern for almost everyone in the company. Senior management of young companies rightfully may be concerned when options are underwater. Taking care of your people and maintaining morale are critical to the success of any company. But a decision on repricing options is one that must be undertaken thoughtfully, with an appreciation and understanding of: a) the magnitude of the issue, and b) what it is precisely that you’re trying to solve.
The first step is to identify the magnitude of the problem, which involves looking at the issue from several perspectives.
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- How many options are underwater? How many people are impacted? How large are the grants? How far underwater are these awards? Is the exercise price significantly above the current fair market value (FMV) or is it only a little bit above FMV?
- How long have these options been underwater? Has this occurred only recently, or has been it several months? How long have these options been outstanding, and how far into the vesting period are they?
- What’s been the history of your FMV? Has it always been stable, or have there been fluctuations?
- What is the likelihood that FMV might rebound in the next one to two years? This is tough, because it’s an important issue; yet no one can predict this with any certainty, of course. Most public companies assume that at some point in the future their stock price will recover, but that is a judgment harder to make when the company is still private. In that case, you may have to look at the prospects for an entire industry or market segment, not just your own company.
- What is the level of concern among employees about the value of their options? Does the company face recurring, long-term concerns about retention of key employees?
- How far off is a likely liquidity event? If it was once seen as a near-term event, but now has been put on hold, has that significantly changed employee expectations and attitudes?
- When was the last time you had a 409A evaluation (an independent assessment of the stock of a private company)? Are you approaching this decision with a realistic, up-to-date assessment of your company’s value?
Depending on the answers to these questions, you may determine that the problem is—or is not—of a magnitude that requires a solution right now. It’s a mistake to decide prematurely. Things could get better, in which case repricing may not have been warranted. Or they could get worse, in which case options could sink deeper underwater and your action may not be sufficient to change things for the better. One thing is certain: you should not be repricing options that are expected to be back above the strike price relatively soon.
It’s a mistake to decide prematurely. One thing is certain: you should not be repricing options that are expected to be back above the strike price relatively soon.
One reason to consider a repricing is that underwater options can tie up potentially significant portions of an equity plan’s share reserve and thus limit the number of shares available to address retention and recruitment. That means a company might need to increase overall share reserves to grant more awards while these underwater options are outstanding—which results in more dilution. And from an accounting perspective, the company is still required to expense outstanding options, even if they’re underwater.
Ali: “What you should not do is simply conclude that your value clearly is lower than it was based on your last 409A and undertake a repricing without a new 409A evaluation in hand. Why? Because that will trigger questions from every investor who comes along down the road and will be very messy to fix. So, valuation first and then repricing.
“You need to be very careful how often you reprice. This is a conversation that Kristin and I have with some frequency because there is no fixed guidance as to how many times is too many. If the IRS deems there is no fixed exercise price on the date of grants, the options will then be deemed to be granted at a discount, thus violating 409A. The advice I give to clients is that the only thing worse than repricing is to reprice more than once.”
The only thing worse than repricing is to reprice more than once.
In Part II, we drill down into the alternatives for repricing options. In Part III, we walk through the process of options repricing.
