What is an ISO 100k Violation?

According to federal securities law, employees are not allowed to receive more than $100,000 worth of exercisable incentive stock options (ISOs) in one calendar year. If a company grants a number of options to an employee that exceeds this amount, any options over the limit will be treated as Non-Qualified Stock Options (NSOs). The $100,000 limit is calculated using the fair market value of the stock for which the options are exercisable, as of the grant date. An important component to the $100,000 limit is that it applies to options that become exercisable for the first time during a calendar year.

For example, let’s say you are the CFO at Company X, and want to grant some options to your employee Thomas Edison. We’ll assume that at the time of the grant (1/1/2020), the fair value of common stock (and by consequence, the strike price of the options) is $0.50 per share. If you grant Thomas 500,000 incentive stock options (ISOs), are you violating the $100k limit? It depends on the vesting schedule. If the options granted to Thomas vest monthly for 48 months (with the first vesting occurring on 2/1/2020), during the first year (2020) roughly 114,583 (11 months’ worth) options will vest, or become exercisable. The aggregate value of the vested options for that year (2020) is 114,583 * $0.50, or $57,291.50. Since this is below the $100k limit, all of the vested options are treated as ISOs.

Now let’s look at a slightly different example. Just as above, we’ll assume that Company X grants 500,000 ISOs with a strike price of $0.50 to Thomas Edison. In this example, however, the vesting schedule is a little different. Instead of monthly vesting for four years, you use a four-year plan with a one-year cliff. 1/4 of Thomas’ options will vest and become exercisable on the 1-year anniversary of the vesting commencement date (1/1/2021), with the remaining 3/4 vesting monthly for 3 years after that. In this case, during the first year (2020) no options vest, because Thomas hasn’t hit his one-year cliff yet. The second year, however, about 239,583 options will vest – 1/4 on 1/1/2021 and 1/48 a month for 11 months. The aggregate value of the vested options for 2021 is 239,583 * $0.50, or $119,791.67. Uh oh, an ISO 100k violation. What this means is that the last $19,791.67 of options must be changed to NSOs to comply with law.

This can become even more complex if the shareholder has several ISO option grants with vesting periods that overlap each other, since the rule applies to each shareholder per calendar year, not per option grant.

For the sake of simplicity we’ll use the first monthly vesting example. 500,000 ISOs that vest monthly, with the first year vesting 11 months. Now let’s assume that Thomas has another grant for 400,000 ISOs that vest monthly over 48 months. We’ll assume the fair market value on grant was $0.50 and a vesting commencement date of 1/1/2019. This means that in the year 2020 the option will vest 100,000 ISOs, or $50,000 worth. The option by itself wouldn’t violate the limit. However, you must account for all ISO option grants. If we add in the $57,291.50 from the previous grant, we get $107,291.50, which puts us over the limit.

Shareworks Startup automatically detects and notifies you in the event of an ISO 100k violation on your cap table. You can view any notifications by going to Compliance > Cap Table Auditor in your left-hand menu:

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From this page click ‘Split Options‘ and the Cap Table Auditor will automatically record your adjustment for you:

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Thomas was issued an ISO option grant of 400,000 as of 01/01/2018. This has pushed Thomas over the ISO $100,000 limit for the calendar year:

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From here you’ll receive a Cap Table Auditor warning letting you know Thomas has exceeded the limit. To have the system automatically split the options go to Compliance > Cap Table Auditor > Split Options.

Once selected, the system will cancel the initial Option grant and create two separate holdings, one for an ISO Grant and one for an NSO Grant under Thomas’ profile:

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Additionally, you’ll see a breakdown of the new custom created vesting schedule that allows up to 100k to vest each calendar year for the ISO grant:

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Similarily a custom vesting schedule has been for the created NSO grant as well, taking the ISO amount into account:

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Note: If the option grant is marked as early exercisable, the full value of the option is applied on the grant date.

You’re done! If you have any questions along the way, you can click your Chat Icon in the bottom right corner of the page or you can also contact us by email at (startupsupport@shareworks.com).

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