For property division in the dissolution of marriage context, it is no longer relevant whether employee stock options are vested. Instead, the relevant inquiry is whether the employee spouse has a presently enforceable right to the options. In re Marriage of Balanson, 25 P.3d 28 (Colo. 2001) reversing in part In re Marriage of Balanson, 996 P.2d 213 (Colo. App. 1999) reversing in part In re Marriage of Huston, 967 P.2d 181 (Colo. App. 1998)(interpreting the “vesting” issue within In re Marriage of Miller, 915 P.2d 1314 (Colo. 1996)). If such a right exists, then it is a property interest, not a mere expectancy. Id.

Once the option has been found to be property, the next step is determining whether it is separate property of the employee spouse, or marital in nature. This determination turns on whether the option was granted in consideration of past services performed during the marriage so as to be marital, or for future services so as to be separate property. In re Marriage of Miller, 915 P.2d 1314 (Colo. 1996); In re Marriage of Sim, 939 P.2d 504 (Colo. App. 1997). Some options have a component of both as of the time of Permanent Orders. In re Marriage of Balanson, 25 P.3d 28 (Colo. 2001) reversing in part In re Marriage of Balanson, 996 P.2d 213 (Colo. App. 1999).

Upon completing the stepped process and concluding that there are employee stock options that are marital property, the next challenge is assigning a value to those options. Discussed below are several valuation methods.


Employee Stock Options – Basic Concepts

Stock option plans have accelerated in popularity in recent years. It is used as a means to reward top management and key employees. It is a contract between an employer and an employee that grants the employee the right to purchase a specified number of shares in the employer corporation at a specified price (the exercise or strike price) for a designated period of time.

Qualified stock options are governed by specific Internal Revenue code sections as to their tax treatment. Incentive stock options are a type of qualified stock option, as well as employee stock purchase plans. Nonqualified stock options are governed by more general principals of compensation and the recognition of income, rather than specific Internal Revenue code sections.

There are three methods for dealing with the division of stock options: current valuation (net present value), deferred distribution (contract agreement) and retained jurisdiction (court stays involved). Our presentation focuses on the current valuation methodology, which results in an immediate distribution to the non-employee spouse by offsetting the value of the options with other marital property.

Relevant Terms:

• Exercise date: The date that an individual or an entity purchases stock pursuant to an option or exercises the “cashless” option.
• Exercise/strike price: The price at which stock can be purchased pursuant to a stock option.
• Expiration date: The day on which an options or futures contract is no longer valid and, therefore, ceases to exist.
• Grant date: The date on which an option is first offered.
• Incentive stock options: This is a type of qualified stock option. The other is an employee stock purchase plan (Code Sec. 423).
• Intrinsic value: The amount by which the value of the underlying stock option exceeds the exercise price of an option.
• Nonqualified stock options: This means that the tax treatment of the options is governed by the more general principles of compensation and the recognition of income.
• Stock price: Price of the underlying stock.
• Time to expiration: The time between now and the expiration date.
• Qualified stock options: This means that the tax treatment of the options is governed by specific code sections.
• Vesting date: The date on which you have the right of ownership for stock options. From this date until the stock options expire, you can exercise the options. This is usually part of a vesting schedule.
• Volatility: A measure of the amount by which a financial variable has fluctuated or is expected to fluctuate. The volatility of a share price is the standard deviation of the continuously compounded rates of return on the share over a specified period.

Employee Stock Options – Basic Value Methods

One basic value methodology is intrinsic value. Intrinsic value is simply the current value of the stock less the exercise (strike) price of the stock option. This approach provides you with today’s value. It attributes no value to the possibility that the stock could increase in value during the term of the option. It ignores the time value of the option. Additionally, this approach fails to recognize that an option may have a positive value even though the stock price is less than the exercise price.

Another basic value methodology is the adjusted intrinsic value. This method takes the current value of the stock and subtracts from that, the present value of the exercise (strike) price at the date of valuation and the present value of the expected dividend stream at the date of valuation, resulting in the adjusted intrinsic value of the stock option. This approach also fails to take into account that the stock could increase in value during the term of the option, but does incorporate some time value.

The values determined by each of the above notes basic value methodologies could be further discounted by income taxes. Nonqualified stock options are subject to ordinary income tax rates upon exercise. Qualified stock options are not taxed upon exercise, but only when the stock is sold at capital gains rates.

Employee Stock Options – Complex Value Methods

One complex value methodology is the Black Scholes model. The Black Scholes formula is a closed-form model. This model uses probability concepts to determine what the option should sell for in the market given the option terms and the stock’s characteristics. It is a model that utilizes an equation to produce an estimated value. The formula takes into account the exercise price, stock price, volatility, time, interest rate and dividend rate. This valuation approach fails to account for the risk of forfeiture before vesting, the marketability of the option and the fact that not everyone wants to hold the option until expiration.

Another complex value methodology is the Binomial Option Pricing Model. This approach utilizes a lattice model (probability concept) – a model that produces an estimated value based upon assumed changes in prices of a financial instrument over successive periods. A binomial model assumes two price movements are possible in each period. The binomial model considers the same factors utilized in the Black Scholes model, but also incorporates the vesting period, early exercise and employee exit rate. The primary weakness with the binomial model is that it is complex and not user friendly.