Summary for Founders
- Use stock options to conserve cash and retain talent
- Set the exercise price at fair market value (“FMV“) on the grant date for Section 409A compliance
- Pick the right structure: Incentive Stock Options (“ISOs”) or Nonqualified Stock Options (“NSOs”)
- Align vesting schedules with biotech milestones and volatility.
- Keep board approvals and cap table records diligence-ready.
Stock Options in Biotech: Structure, Tax and Retention Impact
Stock options can help you conserve cash while bringing in great people early, when things move fast and every dollar matters. Once you start granting options, the legal, tax and governance details start to matter.
This guide breaks down how stock options work, how the exercise price is set at the grant date and the main option types and tax implications. It also helps you walk into your legal counselor’s office prepared.
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Key Terms Used in This Article
Before we get into the mechanics of biotech equity, here are the key terms we will use throughout this guide. A quick read now will make the sections ahead easier to follow.
| Term | Definition and Startup Context |
| Stock option | The right to buy company stock for a fixed period of time at a fixed exercise price. Biotech startups use options to conserve cash while offering employee equity tied to long-term upside. |
| Exercise price | Also called the strike price. The fixed price the option holder pays per share when exercising an option. In a private company, it should be set at or above fair market value on the grant date to comply with Section 409A of the Internal Revenue Code |
| Grant date | The date the company approves and grants the option. This date matters because it anchors the exercise price, starts vesting and drives tax treatment and documentation. |
| Vesting schedule | The timeline that determines when options become exercisable. Vesting is a primary retention tool in biotech because clinical and regulatory timelines are long. |
| Fair market value (“FMV”) | The value of a share at a specific point in time, used to set the exercise price at grant. In life sciences, FMV can shift quickly after equity financings, data readouts or Food and Drug Administration (“FDA”) developments. |
| Underwater options | Options where the exercise price is higher than the current value of the common stock. Underwater options have little or no incentive value until valuation recovers or the company addresses the overhang. |
How Stock Options Work
A stock option is a contract that gives an employee the right but not the obligation to buy shares in the future at a fixed exercise price, even if the FMV of the shares has risen.
The grant date matters because it sets the option exercise price based on current market value. In biotech, grants made before a major data readout for key drug candidates can carry very different upside than grants made after.
Here is what drives whether options motivate:
- Price lock: Options have current value only if FMV rises above the exercise or strike price. When options go underwater, motivation may drop.
- Vesting leverage: Vesting schedules control when options become exercisable. Vesting, not the grant itself, creates staying power for early hires.
- Outcome sensitivity: Life sciences valuations move with trial results and regulatory decisions. That volatility creates employee flexibility, but it can also make protecting employee equity harder.
Many biotech companies issue one of two types of stock options:
- Incentive Stock Options (“ISOs”)
- Nonqualified Stock Options (“NSOs”)
Both grant the right to buy shares at a fixed exercise price, but they differ in eligibility and tax treatment.
ISOs are generally limited to employees and may offer favorable tax treatment if holding requirements are met. NSOs can be granted to employees, consultants and advisors, but typically trigger ordinary income tax at exercise.
For a deeper breakdown of how these structures differ and when each makes sense, see our article on ISOs vs NSOs.
Where Stock Options Can Quietly Fail
Stock options are powerful in biotech, but they are not automatically effective. Long development timelines, binary valuation swings and delayed liquidity can weaken the connection between effort and upside.
If the structure does not match scientific reality, equity can drift from motivation to frustration without anyone saying it out loud.
| Failure Point | Why It Fails in Biotech |
| Liquidity is too distant | Employees may vest for years but cannot realistically exercise or sell shares. Without a credible path to liquidity, stock options feel abstract rather than valuable. |
| Binary valuation risk | Biotech value moves in sharp jumps after trial data or regulatory decisions. Years of work can be wiped out by one failed readout, breaking the link between steady effort and reward. |
| Strike price timing risk | The exercise price is locked at the grant date. If grants are issued after positive data, the strike price may already reflect much of the upside, reducing perceived value and fairness across hires. |
| Underwater options after volatility | When current market value falls below the strike price, options lose incentive power. In biotech, recovery can take years, turning equity into dead weight instead of retention leverage. |
| Vesting misaligned with milestones | Most companies use time-based vesting, but biotech value is milestone-driven. If vesting does not align with clinical inflection points, equity may not retain key employees through the moments that matter most. |
Tax Implications Founders Should Understand Before Issuing Options
Section 409A and Why Grant Timing Matters
Section 409A requires the option exercise price to be at or above FMV on the grant date. If you price below FMV, option holders can face additional tax, interest and penalties.
Because life sciences valuations can move quickly after a data readout or FDA development, timing matters. Granting options after an inflection point but before valuation updates can create 409A risk.
ISOs vs NSOs: Who Bears the Tax Hit and When
Both option types grant the right to buy shares, but tax timing differs and that affects how equity feels during long clinical timelines.
| Feature | Incentive Stock Options | Nonqualified Stock Options |
| Eligibility | Employees only | Employees, consultants and advisors |
| Tax at exercise | No regular income tax, possible Alternative Minimum Tax (“AMT”) | Ordinary income tax on the spread |
| Tax at sale | Capital gains if holding rules are met | Capital gains above exercise price |
| Core risk | Tax exposure before liquidity if sold too early | Cash tax due at exercise |
In biotech, employees can face tax before they can sell shares. That risk becomes sharper when valuations spike on trial results and options are exercised in that window.
A Founder Checklist Before Granting Stock Options in a Biotech Startup
Before you finalize an offer, run these checks to confirm stock options will still motivate through timeline slips and price volatility.
- Goal: Are you using employee equity to recruit now or retain talent through the next critical growth stage?
- Vesting fit: Do existing vesting schedules track the next real value inflection point or do they vest before meaningful data?
- Exercise price credibility: Would the exercise price still feel fair after a down round or does it risk going underwater fast?
- Grant date hygiene: Is the grant date approved by the board and cleanly reflected on the cap table for diligence?
- Volatility stress test: Does the plan mitigate volatility or does it create underwater options quickly and weaken long-term employee compensation?
- Tax clarity: Can you explain ISO vs. NSO consequences and the risk of tax before liquidity in plain terms?
- Diligence readiness: If an acquiring company reviewed the equity packages tomorrow, would it see consistent terms or special deals that slow buyout scenarios?
How We Help Biotech Founders Structure Stock Options
Crowley Law LLC is a boutique law firm with decades of experience advising life sciences and other technology startups. We work with founders at formation, through financings and into exit, designing equity structures that reflect the realities of clinical risk, regulatory timelines and investor scrutiny.
We help our clients:
- Design equity incentive plans that fit biotech timelines rather than default templates built for software companies.
- Structure option pools strategically in anticipation of venture financing and dilution pressure.
- Draft and implement compliant ISO and NSO grants with clear board approvals and cap table alignment.
- Coordinate Section 409A valuation timing so exercise price decisions withstand tax and diligence review.
- Align stock options with employment and intellectual property agreements to protect employee equity and ownership integrity.
- Evaluate vesting, acceleration and post-termination exercise terms so retention mechanisms hold through a critical growth stage.
- Prepare equity packages for investor and acquiring company review to reduce friction during financing and buyout scenarios.
Equity is one of the few levers biotech founders control early. If you are preparing to grant stock options or reassessing existing equity before your next financing, contact Crowley Law LLC to structure a compensation package that supports retention, protects employee equity and stands up to scrutiny.
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FAQs
| Question | Answer |
| How Do We Know if Stock Options Are Still Motivating Our Team? | Options motivate only when employees believe progress can translate into real upside. If options are underwater or vest far ahead of meaningful data, motivation usually drops even if no one says it directly. |
| What Happens When Employee Options Go Underwater in a Biotech Company? | Underwater options lose incentive value. In biotech, that often shows up as a retention problem: harder to keep high performers, more pressure for cash compensation and increased scrutiny during diligence. |
| Should We Ever Reprice or Restructure Underwater Options? | Sometimes, but it is a governance decision, not a quick morale fix. Repricing can trigger investor pushback and diligence questions, especially if it looks inconsistent or poorly documented. |
The foregoing analysis is for educational purposes only and does not constitute legal advice. You should engage an experienced lawyer to help you deal with any issues of this type as they apply in your unique situation.