Expected Term

WHAT IS EXPECTED TERM?

The Expected Term of an option grant is the length of time the grant is expected to be outstanding before it is exercised or terminated. Since most employees who hold private market stock options tend to exercise their options before they expire due to termination or potential liquidity events, the expected life is shorter than the actual contractual term of the grant.

The expected term of a grant is one of the main assumptions used in the Black-Scholes fair value calculation. Many variables can affect the expected term or the expected life of the option grant, including but not limited to:

  • Historical exercise patterns
  • Employee demographics
  • Termination rates
  • Expected volatility of the underlying stock
  • Price of the underlying stock

However, as a private entity, some of these variables may be difficult, if not impossible, to reasonably determine due to the scarcity of data available. The SEC responded to this with a “practical expedient” or proposed solution for option grants deemed to be “plain-vanilla” known widely as the Simplified Method or mid-point method, which is described in the Staff Accounting Bulletin 107 (SAB 107) found here.

CALCULATING EXPECTED TERM

Carta follows the same methodology as described in SAB 107 for all employee option grants. This calculation is applied to each grant. SAB 107 describes the use of a simplified method for plain vanilla options with insufficient exercise history. The simplified method’s formula is:

Here is a snippet from a sample excel spreadsheet to follow along:

*The Expected Term worksheet will be listed below*

The first step is to determine the weighted average remaining time to vesting for each tranche. Carta does this by using the following equation: 

*Expected Term Worksheet*

The Weighted Average Time to Vest is then divided by the number of shares granted to arrive at the Weighted Average Vesting Term.

The next step is to determine the Contractual Term, which is simply defined by the following equation

The commonly accepted way of defining contractual term is simply the expiration date minus the grant date, divided by the number of days in the year. Some entities prefer to use 360 or 365 day-count, but Carta uses 365.25 days to account for Leap years.

Once you have both the Vesting Term and the Contractual Term, simply sum the Weighted Average Vesting Term and the Contractual Term and divide by 2.

EXPECTED TERM CALCULATION FOR NON-EMPLOYEES

Non-employees use a remaining contractual life to measure the remaining life of an award. The remaining contractual life is defined by the following equation:

Prior to adoption of ASU 2018-07, companies are required to re-measure non-employee option grants until they vest under ASC505-50. To comply, the expected term of non-employee option grants is re-measured each reporting period until the award vests. For a grant whose vest date is before the reporting period end date, the expected term will be the grant expiration date less the vest date. For grants whose vest date is after the reporting period end date, the expected term will be the expiration date less the reporting period end date. 

Once both dates have been established, take the difference of the two and divide it by 365.25 to arrive at the remaining contractual life of a grant. 

What is "Expected Term"                                                                                                         Interest Rate Calculation

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