With the stock market reaching new heights, stock options are again in vogue, and may offer a way for satellite and space sector companies to attract and keep valuable employees. However, the burning many option holders experienced during the great recession will likely make employees more discriminating about option grants, under what circumstances to accept them and in lieu of what compensation.

Throughout the telecom and Internet bubble of the 1990’s, companies in the technology sector with high growth/low cash flow business plans counted on grants of stock options to attract and keep key employees. Options had a number of attractive features: They were prized by employees who assumed that the market price – or “fair value” – of the stock underlying the options would exceed the exercise price at the time of exercise, meaning the options would be “in the money,” and that the value of the optioned stock would continue to rise; they did not cost the issuing company cash; they were subject to “vesting” schedules that bound the employee to the company; they incentivized the employees’ interest in the company’s performance; and they were not counted as an expense on the company’s income statement, as was other compensation, resulting in higher profits and greater attractiveness to investors, than had the options been “expensed.”

All that changed, of course. The bubble burst and the intended stock price accretion never occurred for many holders. Instead of being in the money, many options were “under water,” with an exercise price higher than fair value until expiration, and therefore effectively worthless, since no option holder will exercise an underwater option. Stocks have rebounded, but many option grants expired under water, and many more were relinquished unvested. None of these developments make stock options illegal or unavailable; they may merely be less attractive to both prospective issuers and holders and therefore a less relevant alternative to cash or other compensation. Considering all this, what is the place of options in both growth and mature satellite sector companies?

The employee stock options we are discussing are technically “call” options, ones that allow the option holder to purchase the issuer’s stock at a specified (or exercise) price within a certain time period in the expectation that the stock’s market price will rise after exercise (“put” options give the holder the right to sell at a specified exercise price; a put option holder hopes and expects fair value to decline below the exercise price). Employee stock options come in two varieties: non-qualified stock options, and qualified, or “incentive” stock options (ISOs). Non-qualified options need not be issued pursuant to an option plan. Assuming some basic compliance, the holder of the options will owe no tax on them until the option is exercised, at which time the employee will incur an income tax liability on the spread between fair value and the exercise price. The issuing company receives a corresponding tax deduction.

By contrast, ISOs must be issued pursuant to an option plan, must have an exercise price of at least 100 percent of fair value at the time of issuance and must expire within 10 years. When properly structured, the option holder incurs no income tax liability when the option is exercised (although Alternative Minimum Tax liability is possible), but only on a later resale of the optioned shares. Assuming the stock has been held for long enough, even that tax liability will be calculated at lower capital gains, rather than higher ordinary income, tax rates. The company receives no tax deduction.

For these reasons, option-issuing companies generally prefer to issue non-qualified options, while employees prefer to receive ISOs. However, given the use of options to attract and retain employees in the absence of ready cash, the ISO was the dominant form of option grant.

In satellite sector companies with existing revenue streams and high growth potential by reason of untapped markets, new technologies or services, option grants can still serve as a valuable incentive. Although the days of modest salaries and large stock option grants comprising the predominant part of compensation are over, for companies that need to sweeten the pot with employees that have reason to believe in their employer’s future success, options can still play a role.

Owen D. Kurtin is the founding member of New York City-based law firm Kurtin PLLC and a founder and principal of private investment firm The Vinland Group LLC. He may be reached at [email protected].