Stock options: Guard the Gold

Use stock options and warrants to pay for service only rarely.

Earlier, I stated that stock options are the currency of early stage business.  This truth is obvious when a start-up has no cash.  For this insight, we will assume a business is perhaps well beyond start-up and growing, but that cash is tight, used for growth and for working capital as earned.  There are times when services of others are available for stock instead of – or in addition to cash.  Such service providers as web designers, public relations firms, even venture banks granting loans, often offer higher value services for a lesser amount of cash and some amount of stock options or warrants (written promises to sell stock at a set price for a future period in time).

When assessing the relative merit of using attractive non-cash forms of compensation for outside services, first be aware of the true value of your stock.  Because the valuation is now a requirement under Rule 409a of the Internal Revenue Code, most companies with stock option plans today have fairly valued common stock with known prices per share.  Second, when making such a decision, assess the speed of growth and risks associated with that growth, as both would affect the value of the common stock.  If an imminent fund-raising effort will be undertaken and the corporate growth is slow, it is logical to fear that the next round will be dilutive and perhaps at a lower valuation than the current value per share. But if the growth is strong enough to anticipate increasing stock valuation over time, then the grants of stock instead of cash for services may in the end prove to be quite expensive to the existing shareholders by involuntarily diluting their holdings.  It is the same logic larger corporations use when deciding whether to use cash or stock to make an acquisition.  If the stock is highly priced, corporations may be quite willing to use their shares as currency for acquisitions.  Such an analysis is in the service of all shareholders.

And remember, any grant of shares or options must be approved by the corporate board before issuance, since it changes the capital structure of the corporation, even if the option pool has been previously approved by the shareholders and board.

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