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Insights & Analysis

Repricing Underwater Stock Options

Repricing Underwater Stock Options

Key Points

  • Before undertaking a stock option repricing program, consider the tax impact on employees holding incentive stock options (ISOs)
  • Additionally, consider the corporate and securities laws that govern repricing programs


Stock options are a vital form of compensation at a wide range of privately-held companies.1 Stock options are intended to motivate employees to drive stockholder value and are used as an employee retention tool. When the exercise price of the stock option exceeds the current fair market value of the underlying common stock (underwater stock options), the option is not motivating employees nor is it acting as a retention tool. Thus, companies often consider repricing underwater stock options. Gone are the days when the accounting rules required variable accounting or the six month and one day exchange programs; however, there are still some tricks and traps when repricing stock options, which are discussed below.

Steps to a Successful Repricing Program

  1. Assess and Prepare
    Review the applicable equity incentive plan documents to determine if there are any contractual limitations on the company's ability to reprice stock options. Identify the options to be repriced. Some companies may only reprice stock options that are severely out-of-the-money. Some companies may exclude officers and directors at the request of their stockholders.

    Determine whether the repricing program will take the form of an exchange program. Underwater options may be exchanged for cash or restricted stock units. Determine the exchange ratio. For example, optionholders may be asked to take a haircut on the number of shares underlying the repriced options.

    This article is focused on the legal considerations applicable to a repricing; however, it is imperative that the company understand the financial accounting consequences of a repricing program. Contact the company's accountants for details.

    Develop a realistic timeline taking into account the tender offer rules described below and coordinate with the company's internal or external stock plan administrator who will take the laboring oar on the administration of the repricing program.
  2. Board Approval
    Any repricing program should be approved by the Board of Directors of the company. Privately-held companies are not required to seek stockholder approval. However, consider the impact of the repricing program on stockholders/investors. Employees are advantaged by a repricing program; however, stockholders/investors do get the same benefits.
  3. Tender Offer
    Even though privately-held companies are not required to file a Schedule TO with the SEC to undertake a tender offer, privately-held companies are required to comply with certain tender offer rules when optionholders are given a choice to participate in the repricing program. The election period to opt in to the program must be at least 20 business days. The stock options should be repriced promptly after the end of the election period.

Tax Considerations

Stock options are either incentive stock options (ISOs) or nonstatutory (non-qualified) stock options (NSOs) for federal tax purposes. Tax law limits the aggregate value of incentive stock options which may first become exercisable in a single calendar year to $100,000. When incentive stock options are repriced both the original grant and repriced grant count toward the $100,000 limit. Any portion of the repriced grant that exceeds the $100,000 limit will automatically be taxed as a nonstatutory stock option.

Under federal income tax law, a repriced incentive stock option will begin a new “holding period,” commencing with the grant date of the repriced option, that must be satisfied to receive the federal income tax advantages potentially available to incentive stock options. If the stock purchased upon exercise of a repriced incentive stock option is held more than two years from the grant date of the repriced option and more than one year from the date of exercise, then the entire gain or “spread” between the exercise price and the sales price will be treated for federal income tax purposes as long-term capital gain at the time of disposition of such stock. If the two-year and one-year holding periods are not met, a “disqualifying disposition” will have occurred and the “spread” on the date of exercise will be taxed as ordinary income. Under current tax law, capital gain treatment will result in a benefit to many taxpayers, since the maximum tax rate on long-term capital gain is lower than the maximum tax rate on ordinary income.


  1. Develop a repricing program taking into account the tax impact on employees and comply with applicable securities laws.
  2. Contact the company's accountants to understand the impact of the repricing program on the company's financial statements.
  3. Communicate to employees the impact of the repricing program on incentive stock options (ISOs).

1 This article is intended for a private company audience. Publicly-traded companies undertaking a repricing program are subject to additional regulatory issues beyond the scope of this article. Please contact Alison Wright at Hanson Bridgett LLP for additional information on public company repricing programs.

For More Information, Please Contact:

Alison Wright
Alison Wright
Walnut Creek, CA