The way I've observed this done, at least for US employees at a US company I've worked at that issued options:
- New hires' offer letters described some details of the options grant they would receive, including the number of options but NOT the exercise price, and said that the grant was subject to board review
- The board review was indeed a formality and everyone got their promised options
- The vesting start date of the options was back-dated to the first day of work (i.e. it was as if your options had begun vesting as soon as you started work), but the exercise price was set to the official "fair market value" of the company based upon the most recent valuation at the time that the board approved the options.
These conditions are obviously not ideal from your perspective as the employee. You would like it if you could be granted your options immediately on day 1 of work, for two reasons:
- It eliminates the risk that your employer will screw you over and not grant you the options they've kinda-but-not-quite-promised to you.
- If the company has a valuation performed between your first day of work and the board meeting when your options are approved, and it happens to result in a significant increase in the company's official valuation, then your exercise price will be higher to reflect this, which reduces the value of your options
So why do companies operate this way? My understanding (which some online sources seem to corroborate) is that it's to avoid legal complications, in part to protect the company and in part to protect you.
Corporate law in the US generally requires documented board approvals for options grants. See e.g. Stock Options: Don’t Forget Board Approval on the Startup Law Blog, which says
Why is it important that you promptly and fastidiously document board approval of stock option grants? Well, because if the options haven’t been approved by the board, they haven’t been appropriately awarded under the corporate law. This can give rise to a variety of complexities and problems.
(I'm not really clear on what would happen if a company didn't follow proper process on this. Would it be as if the options hadn't been issued? Surely part of someone's compensation can't evaporate years down the line because of a bookkeeping error by their employer? I imagine most companies would rather not find out how any of this plays out if they get the bookkeeping wrong... and probably you, as an options recipient, would rather never have to find out either.)
There are horrible tax consequences for YOU if the company grants you options whose exercise price is less than the fair market value of the stock on the date of the grant. Per law firm HansonBridgett:
The general rule is that the exercise price of the stock option cannot be less than the fair market value of the stock underlying the option determined on the date of grant. If an option is granted with a discounted exercise price, the tax consequences for the employee or advisor receiving the option can be severe. In order for an incentive stock option ("ISO") to qualify as an ISO, the exercise price of the stock option cannot be less than the fair market value of the stock underlying the option determined on the date of grant. An ISO granted at a discount is automatically re-characterized as Nonstatutory Stock Option ("NSO"). An NSO granted at a discount is in violation of Internal Revenue Code Section 409A. A violation of Code Section 409A results in the employee or advisor being taxed in the year the option is vested (instead of when the option is exercised) and the employee is subject to a 20% penalty tax on top of income tax.
These all sound like things you don't want to happen to you!
In summary, then, this is a conventional way for US startups to operate, and by itself it is not a sign that your prospective employer is doing anything shady. It does have some consequences that are adverse to your interests, but those are almost certainly not the reason the company is doing things this way; rather, they are simply ensuring they comply with the law. As such, there is no sense in fighting over these terms; it is likely the company wants to offer you better ones but dares not do so out of fear of the law, and all you can do, like them, is grudgingly accept it.
As part of this standard way of operating, the company probably does get the opportunity to basically scam you by not issuing the options they promised you, and you would likely have no legal recourse if they did. However, I would not be too worried about this possibility unless they have acted in other ways that give you cause to distrust them. Frankly, the cost to a startup of pissing off an employee and having them quit a few months into the job is likely greater than any benefit they'd get by clinging on to a little bit of extra equity, so your employer would have to be both evil and stupid to decide to stab you in the back in this way.
To the extent that there's something to be annoyed about here, you should be annoyed at your politicians, who have created the legal environment that compels companies to operate this way, and not at your employer themselves. Their corporate counsel has likely insisted they handle options grants this way to avoid legal trouble.
