CONTENTS
- 1. Stock Options | Definition
- - Difference From Shares
- - Advantages of Stock Options
- 2. Stock Options | Eligible Recipients
- - Special Provisions for Stock Option Grants by Venture Businesses
- - Recipients Subject to Grant Restrictions
- - Equity Dilution from Excessive Stock Option Grants
- 3. Stock Options | Grant Procedures and Required Conditions
- - Establishing Provisions in the Articles of Incorporation in Advance
- - Special Resolution of the General Meeting of Shareholders
- - Preparation of the Stock Option Grant Agreement
- 4. Stock Options | Points to Note
- - Legal Support
1. Stock Options | Definition
Stock options are used as a means of motivating executives and employees and encouraging long-term retention by promising compensation tied to the company's future growth in a corporate environment where cash compensation is limited.
Legally, as a ‘stock purchase option’ under the Commercial Act, it refers to a system in which a company grants its executives and employees the right to purchase the company's shares at a predetermined price after a certain period has elapsed.
This is distinguished from an ordinary share transfer in that it grants an option to acquire shares in the future, rather than transferring shares immediately.
Being granted stock options does not mean that one immediately acquires the status of a shareholder.
Shares are acquired only when the minimum period of service set by the Commercial Act (two years from the grant date) is met and the right is exercised within the prescribed exercise period.
This process requires strict legal procedures, including a special resolution of the shareholders' meeting, revision of the articles of incorporation, and preparation of the grant agreement.
In this way, stock options go beyond an incentive system and are an institution that directly affects the company's governance structure and the rights of existing shareholders, an area that requires sufficient legal review in advance.
Difference From Shares
Stock options and shares are both concepts related to a company's equity, but there is a clear difference in their legal nature and the point at which they take effect.
▶ Shares
▶ Stock Options
At the stage when stock options are granted, there are not yet any shares attributable to the recipient, and the recipient becomes a shareholder only at the time the right is exercised, through means such as the issuance of new shares.
In other words, stock options are distinguished from already established shares in that they are a conditional right premised on the future acquisition of shares.
In addition, while shares can be disposed of through transfer, inheritance, and the like, stock options are in principle restricted from transfer, and their exercise requirements and period are strictly managed in accordance with the grant agreement and statutory provisions.
Because of these differences, stock options are treated as a legal institution that affects the company's governance structure while also serving as a means of compensation.
Advantages of Stock Options
Stock options offer the following advantages.
① Minimizing cash burden
Because a compensation structure can be designed without raising salaries, this helps minimize cash outflow.
② Encouraging long-term retention and performance
As a result, this can encourage participation in and accountability for the company's medium- to long-term growth rather than short-term results.
③ A means of securing key talent
④ A favorable factor in the process of attracting investment
However, these advantages carry meaning only when the grant requirements and procedures set out in the Commercial Act have been satisfied.
Stock options that do not meet the requirements may later lead to claims of invalidity or to disputes, so a prior review is indispensable.
2. Stock Options | Eligible Recipients
Stock options are not a system that can be granted freely to anyone.
To prevent the dilution of equity and the impairment of governance structures caused by the abuse of stock options, the Commercial Act and the Act on Special Measures for the Promotion of Venture Businesses clearly limit who may receive grants and the scope of those grants.
In particular, for startups recognized as venture businesses, more relaxed standards apply than for general companies, but this too is possible only within the scope set by law.
Therefore, when designing stock options, distinguishing between eligible recipients and restricted recipients must come first.
Special Provisions for Stock Option Grants by Venture Businesses
If a company is recognized as a venture business, it may grant options to a broader range of recipients than a general company under the Commercial Act.
▶ Grants to officers and employees
ㆍ Employees of the company (including full-time and contract employees)
▶ Grants to outside experts
ㆍ Researchers and specialized research institutions
ㆍ Outside experts who provide technical or management advice
This special provision is a system designed to help startups secure key talent and specialized personnel, and it applies only to venture businesses.
In addition, for venture businesses, the grant limit may be expanded up to 50% of the total number of issued shares.
However, even though the limit has been expanded, this does not mean there are no restrictions in practice.
▶ Restrictions after attracting investment
ㆍ It is also common to make stock option grants subject to the prior consent of investors
Therefore, even for a venture business, failing to also review the restrictions under the investment agreement and the shareholders' agreement may lead to disputes with investors during the grant process.
Recipients Subject to Grant Restrictions
Even for a venture business, grants are restricted for persons holding certain positions.
The main recipients to whom grants are restricted are as follows.
▷ Persons who in practice exercise influence over the company's major management matters
▷ Specially related persons, such as the spouse and the lineal ascendants and descendants of such persons
This is a safeguard to prevent stock options from being used to maintain management control or as an improper means of transferring equity.
Stock options granted in violation of these restrictions may later lead to disputes over their validity, so particular care is required.
Equity Dilution from Excessive Stock Option Grants
Stock options are an effective system for securing talent, but if the size of the grant is excessive, it may lead to the dilution of existing shareholders' equity.
When stock options are exercised, new shares are issued or shares are transferred, which has a direct effect on the rights of existing shareholders.
The problems that may arise from excessive grants are as follows.
▶ Reduction in existing shareholders' ownership ratio
▶ Instability in the management control structure
▶ Restrictions in the process of attracting investment
▶ Effect on the company's valuation
Therefore, it is important to design stock options within a scope that takes into account future fundraising and changes in the equity structure.
Granting stock options without a comprehensive review of the recipients, the quantity, and the timing of exercise may lead to disputes or management risks.
3. Stock Options | Grant Procedures and Required Conditions
Stock options are not a system that can be granted by the agreement of the parties alone.
If the procedures and requirements set out in the Commercial Act and the Act on Special Measures for the Promotion of Venture Businesses are not met, the stock options themselves may be deemed invalid.
Therefore, it is important to accurately satisfy the formal requirements from the design stage.
Establishing Provisions in the Articles of Incorporation in Advance
In order to grant stock options, the articles of incorporation must contain a supporting provision.
The articles of incorporation should include the following matters.
▷ Scope of eligible recipients
▷ Type and number of shares that may be granted
▷ Exercise period and key conditions
Stock options granted without a supporting provision in the articles of incorporation may later become the subject of a claim of invalidity or a dispute.
Special Resolution of the General Meeting of Shareholders
The grant of stock options is, as a rule, made through a special resolution of the general meeting of shareholders.
Unlike a salary agreement, the grant of stock options is not a matter that the representative director may decide alone, and it must be resolved through the general meeting of shareholders in accordance with the procedures set out by law.
The general meeting of shareholders should specifically resolve the following matters.
▷ Number of shares to be granted
▷ Exercise price
▷ Exercise period
▷ Other key conditions
A special resolution is required rather than an ordinary resolution, because stock options directly affect the equity interests and voting rights of existing shareholders.
For a special resolution to be established, the approval of at least two-thirds of the voting rights of the shareholders present is required, together with the approval of at least one-third of the total number of issued shares.
Preparation of the Stock Option Grant Agreement
After the resolution of the general meeting of shareholders, an individual stock option grant agreement must be concluded with each recipient.
The grant agreement is a document that gives concrete shape to the content of the shareholders' resolution as actual rights, and it serves as the reference document for determining whether and to what extent rights may be exercised in the future.
For this reason, the following key matters should be clearly stated in the agreement.
▷ Exercise price and method of exercise
▷ Minimum period of service
▷ Period during which exercise is possible
▷ Treatment upon resignation or dismissal
In particular, provisions relating to resignation or dismissal are the area where stock option disputes most frequently arise, and if clear standards are not set in advance, they may lead to disputes over the existence of rights.
For this reason, the grant agreement should be managed not as a formal procedure but as a key mechanism for preventing actual legal disputes.
4. Stock Options | Points to Note
Depending on how stock options are managed at the exercise stage, a compensation program can turn into a source of disputes.
In practice, the following matters require particular attention.
▷ Reviewing the Articles of Incorporation and the Agreement
▷ The Importance of Setting a Vesting Schedule
After the legally required minimum period of two years of service, a vesting schedule is designed so that the options can be exercised in installments based on performance.
▷ Considering the Effect on Company Funds and Accounting
However, because new shares are issued, accounting and tax issues may also arise.
Therefore, it is necessary to check in advance the cash flow resulting from exercise and its effect on accounting and tax treatment.
▷ Checking the Investment Agreement and Exit Structure
In particular, you should check whether the investment agreement contains any restrictions or consent clauses.
Legal Support
If the recipients, the quantity, and the exercise requirements of stock options are not clearly designed, they may later lead to disputes among officers and employees, objections from investors, and disputes over rights upon resignation.
In particular, even where the stock option special provisions for venture companies apply, legal risks may arise if the provisions of the articles of incorporation, the shareholders' resolution, and the restrictions under the investment agreement are not reviewed in a comprehensive manner.
Daeryun Law Firm provides practice-oriented legal support that takes overall corporate operations into account.
It also presents response strategies that reflect everything from the design of the grant structure to the possibility of future disputes.
If you face a situation that requires legal review in relation to stock options, you may manage the risks in advance together with a startup attorney at any time.
See More
