[Column] Venture Company Stock Options, Can't Give Them Away Cheaply Now?

Startups are always eager for talent. They offer creative environments, new challenges, and passionate colleagues to attract talented people. However, in many situations, the biggest incentive is giving them the opportunity to “ride shotgun” – meaning to gain stock options.

A stock option is a right granted to an employee to buy the company’s shares at a relatively low price over a long period. For smaller, early-stage startups, the value can increase dramatically depending on the skills of a few key employees, and granting stock options can accelerate the company's growth. Stock options can make employees feel like they are part-owners of the company and share in the company’s growth.

When a startup offers stock options to its employees, it considers various factors, including the timing of the offering, the number of shares, and the vesting schedule. The most crucial decision is the strike price – the price at which the employee can buy the shares after a certain period.

From an employee’s perspective, the lower the strike price, the better. Even if the company’s stock price drops, they can still profit. From the company’s perspective, a higher strike price allows it to recognize more stock appreciation, and it can also serve as a stronger incentive for employees to focus on the company’s work. Employees who receive stock options are motivated to act like owners and maximize their potential value.

In principle, the strike price for venture company stock options, until February 2, 2022, was calculated using the official method, as stipulated in Article 16(3) of the Venture Company Act and its implementing regulation Article 11(3) (2) – a weighted average of the book value and net asset value on the issuance date. (1) The remaining factors were determined through negotiations between the company and the employee. However, for private companies, it is difficult to accurately determine the market price of the shares.

Until February 2, 2022, the Venture Company Act stipulated that the valuation method for private venture company shares was based on the official method as stipulated in Article 16(3) of the Venture Company Act and its implementing regulation Article 11(3) (2) – a weighted average of the book value and net asset value on the issuance date. ⁽²⁾ This formula meant that many startups and venture companies with low book values and net asset values could have their stock prices calculated as close to zero, allowing them to freely determine their stock option strike prices.

However, on February 22, 2022, the Venture Company Act was amended, resulting in a change to the valuation formula. The new regulation allows the valuation of private venture company shares using (i) trading price if there is a trading record (average over 6 months prior to and after the issue date), (ii) appraised value by a valuation firm, (iii) auction price, (iv) other valuation criteria determined by the Tax Office Appraisal Committee. ⁽³⁾

When stock prices are calculated this way, the company’s actual valuation (valuation) can become the lower limit for the stock option strike price. It also becomes less likely that a startup will be highly valued in the market but have low operating profits or asset values, leading to a lower stock option strike price. Consequently, startups seeking investment or selling shares to investors may find it harder to use a low-priced stock option to incentivize employees.

Stock options are undoubtedly a useful weapon in the battle for talent. However, the legal regulations surrounding startup stock options are complex, and they can change quickly, especially before they are widely publicized. When designing stock option plans, it is essential to consider various legal constraints and business conditions.

(1) Venture Company Act, Article 16(3) (10), Implementing Regulation Article 11(3) (2)

(2) Amended Venture Company Act Implementing Regulation Article 11(3) (2)

(3) Amended Venture Company Act Implementing Regulation Article 11(3) (2) (1) (a), Inheritance and Gift Tax Act Article 60, Inheritance and Gift Tax Act Implementing Regulation Article 49, [Korea Policy Briefing, “Venture Company Stock Options, Valuation Methods for Private Shares Diversify,” February 15, 2022”]