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Valuation of Stock Options in Divorce

VALUATION OF STOCK OPTIONS IN DIVORCE

When spouses divorce the assets of the marriage are typically divided in half. More specifically, all community property, most property acquired during the marriage, is split equally with few exceptions. Prior to a division of assets there must be a valuation of those assets. Stock options create a unique valuation hurdle for a few reasons. A stock option provides for a holder to buy a pre-determined number of shares, at a set price, over a number of years. The price at which the holder acquires the stock for in the future is typically locked in as the same price the stock was selling for on the day of the grant.

Stock options are often given to high level executive employees. Since the stock option allows for the executives to have equity in the company the option holder executives are incentivized to perform well for the company so that their stock options will increase in value. Often times startup companies and smaller companies cannot afford to compensate highly credentialed executives. Given the company's inability to provide for the executive's substantial salary, the company issues stock options to the executive as compensation for the lack of salary the executive would otherwise receive. As the company grows the value of these stock options may grow substantially. It is not uncommon for the most valuable asset in a divorce to the stock options obtained by one or both spouses.

Stock options can be classified into three different groups. The first category is accrued and matured. These stock accrue when the employee has an absolute right to it. The option has matured when the employee can exercise the option, thereby realizing financial gain. Oftentimes the accrual date and maturity date will be the same, however there are times when the option agreement will provide for an accrual date which proceeds the maturity date. This is analogous to a pension which first vests and then later matures. If the stock option has both vested and matured then it is a near liquid asset. These are the easiest stock options to divide in divorce. The second category of stock options are those which have accrued but not yet matured. These employees have an absolute right in the stock option but have to wait until a certain contingency has taken place, typically the passage of time, before they can exercise such option. The third category are those that are unaccrued and unmatured. These options are the most difficult to value as they have the most uncertainty regarding future transformation into cash.

Courts vary from jurisdiction to jurisdiction as to whether or not they consider these stock options to be community property. The reason for this variance is partially due to how each state interprets community property. Generally speaking community property is defined as property earned or acquired during the marriage. The interesting thing about stock options is that it can be difficult to determine when those options were earned. Most courts have decided that stock options granted for past services are community property, assuming that past service occurred during the marriage. If the options are granted in consideration for future services and the employee must complete these services to qualify for the option then courts will typically apply the time rule to determine what portion of the option is community verses separate property. That portion of time devoted to completing those required services post-divorce will be attributed to separate property of the employee spouse. There are times when stock options will issue to an employee in recognition of past services. If those past services occurred prior to the marriage then that pre-marital portion will be classified as the separate property of the employee spouse while the service time completed during the marriage will be considered community property.

To determine if the stock options were granted for past, present, or future employment courts must look to several factors. The first is the context of the grant. Were stock options granted in lieu of what would otherwise be a reasonable salary? If so then the stock options were likely granted for present employment. The language of the stock option plan may assist the practitioner in determining what period of service the options were granted for. The plan may specifically state that the stocks are granted for the purpose of retaining the employee for a number of years going forward. This would be indicative of a grant for future employment. The community has no interest in stock option grants for future employment which has yet to transpire.

Another issue is how the courts are to divide this asset upon dissolution of marriage. Some courts will retain jurisdiction over the stock options until the time when the option can be or are in fact exercised. At this later date, the court can effectively split the value of the option. If the court chooses not to "wait and see" what the option will ultimately be worth at exercise date then the court will have to value to the options at dissolution of marriage. This will likely require the assistance of an expert. Be mindful that some courts in this country do not consider unvested stock options to be community property at all. This is because these courts see these stock options as a mere expectancy and therefore not community property as the holder of these options has no enforceable rights at least until these options vest.

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