How do we process an option exercise by an employee?
Takeaway: Processing an option exercise requires a clear notice from the employee, receipt of full payment, and proper issuance of shares recorded in the company’s cap table. Board approval is not required at the exercise stage.
An employee exercising their stock options is a positive event. It means they believe in the long-term value of your company and are willing to invest their own capital to become a stockholder. While this is exciting, it is also a formal legal and financial transaction that must be handled with a precise, documented process. Simply accepting a check from an employee is not sufficient.
The process for handling an option exercise should be a standard, repeatable workflow for your company.
The Step-by-Step Exercise Process
The Employee Initiates the Exercise: The employee notifies the company of their intent to exercise a specific number of vested options. They will typically sign a formal Exercise Agreement, which your law firm or cap table platform can provide.
Payment is Delivered: The employee delivers full payment for the shares. The payment amount equals the number of shares exercised multiplied by the fixed exercise price from the option grant. This is almost always handled electronically through a cap table platform (via ACH or wire transfer).
The Company Issues the Stock: Once payment is received, the company issues the shares. Today, this is handled electronically through your cap table management platform, which will issue an updated stock certificate and reflect the employee’s ownership. No additional board approval is required at this step, since the board already approved the option grant at the time it was made.
A Critical Tax Consideration: NSO Withholding
One major compliance step is often overlooked. If the employee is exercising a Non-qualified Stock Option (NSO), the “spread” between the Fair Market Value (FMV) at exercise and the exercise price is considered taxable wages.
The Company’s Obligation: The company must withhold applicable payroll taxes (income tax, Social Security, Medicare) on the spread, just as with regular salary.
The Process: The employee typically provides two payments: one for the exercise price, and another for the required tax withholding. Your payroll provider should be involved to ensure proper withholding and remittance to tax authorities.
Having a clean, standardized process for handling option exercises demonstrates professionalism to your employees and keeps your equity records compliant and audit-ready.
Disclaimer: This post is for general informational purposes only and does not constitute legal, tax, or financial advice. Reading or relying on this content does not create an attorney–client relationship. Every startup’s situation is unique, and you should consult qualified legal or tax professionals before making decisions that may affect your business.