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Evergreen Options: Definition, Mechanism, and Implications

Last updated 03/15/2024 by

Alessandra Nicole

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Summary:
Evergreen options, a component of employee stock option plans (ESOPs), provide employees with additional shares annually without a set expiration date. This article delves into the definition, workings, advantages, limitations, and taxation implications of evergreen options, catering to the finance industry’s professionals.

What is an evergreen option?

Definition and core concepts

An evergreen option, referred to as an “evergreen provision” or “evergreen plan,” is a facet of certain employee stock option plans (ESOPs). Under this arrangement, participating employees automatically receive additional shares each eligible year, usually without a predetermined expiration date.

Understanding evergreen options mechanism

Evergreen options operate by allocating a percentage of the company’s common shares outstanding to determine the annual issuance of options. For example, if a company with 75 million outstanding shares incorporates a 5% evergreen option provision, it could grant 3.750 million shares as compensation in the first year. Subsequently, with an increase in shares outstanding each year, the allocation of evergreen options is adjusted proportionally.
WEIGH THE RISKS AND BENEFITS
Here is a list of the benefits and drawbacks to consider.
Pros
  • Provides additional compensation to employees beyond salaries.
  • Aligns the interests of managers and employees with those of shareholders.
  • Enhances employee retention and motivation.
Cons
  • Dilutes earnings and voting rights for existing shareholders.
  • Potential adverse impact on shareholder value, especially during poor company performance.

Frequently asked questions

What are the requirements for evergreen options to be granted?

Evergreen options are typically granted automatically each eligible year without requiring shareholder approval. However, the board of directors must approve the number of shares allocated to the plan annually.

How are evergreen options taxed?

Evergreen options, if granted as incentive stock options (ISOs), are non-taxable at the time of grant. Taxation occurs when the shares are sold, with gains treated as ordinary income if sold immediately or as long-term capital gains if held for a specific period.

Key takeaways

  • Evergreen options provide employees with additional shares annually without a set expiration date.
  • These options help companies attract and retain talent while aligning employee interests with shareholder value.
  • However, evergreen options can dilute the ownership percentage of existing shareholders, impacting shareholder value.

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