For growing startups, offering stock options is one of the most powerful ways to attract and retain talent. But without the proper legal guidance, what seems like a simple perk can lead to significant regulatory and financial headaches down the line.
Here are five common mistakes founders make when issuing employee stock options—and how to avoid them.
1. Not Having a Legally Compliant Option Plan in Place
Founders often promise equity to early employees before setting up an actual stock option plan. While this is typically done with good intentions, informal or undocumented promises can lead to disputes and legal exposure.
A properly drafted and board-approved equity incentive plan is essential. It outlines how options will be granted, vested, and exercised—and ensures that your company remains compliant with tax, corporate, and securities laws.
What to do instead: Work with legal counsel to adopt an equity plan early, ideally alongside incorporation or your first fundraising round.
2. Issuing Options Without a 409A Valuation
Setting the right strike price is critical. If you issue options with a strike price below fair market value and haven’t obtained a proper valuation, employees could face unexpected tax consequences—and your company could face penalties.
Under IRS regulations (Section 409A), private companies must obtain an independent valuation to justify the strike price. This is not optional—it’s a legal and tax requirement.
What to do instead: Get a 409A valuation before issuing any options and update it at least once a year or after material events (like a financing round).
3. Failing to Keep Proper Records of Grants
Sloppy documentation—or none at all—can delay funding and cause red flags during diligence. You should maintain clear records of every grant, including board approvals, signed option agreements, vesting schedules, and cap table updates.
What to do instead: Use a secure equity management system or legal support to track and organize all option grants. Clean records today can save you significant legal and financial cleanup costs in the future.
4. Misunderstanding Vesting Terms
Offering stock options is not just about compensation—it’s also about retention. Standard vesting schedules (e.g., 3 years with a 1-year cliff) protect the company from granting equity to someone who may leave early.
But founders sometimes forget to include vesting at all—or create custom terms without understanding the long-term consequences.
What to do instead: Use standard vesting unless there’s a compelling reason to modify. Make sure the terms are clearly defined in your agreements and understood by the team.
5. Over-allocating or Promising Too Much Equity
In the excitement of hiring early employees or advisors, founders may promise large chunks of equity without realizing the long-term dilution impact. Equity is a limited resource—giving away too much early on can complicate future fundraising and limit flexibility for future hires.
What to do instead: Map out a hiring plan and budget your option pool strategically. A corporate lawyer can help you model dilution scenarios and set realistic expectations with candidates.
Final Thoughts
Equity is one of your startup’s most valuable tools. Done right, it can align incentives, attract top talent, and power growth. But if mismanaged, it can lead to disputes, lost trust, and missed opportunities.
At Zecca Ross Law, we help founders navigate equity grants, cap table structure, and employee incentives with clarity and compliance in mind. If you’re planning to issue options—or want to clean up past grants—let’s talk.