6. Convertible Preferred Stock and Stockholders’ Equity

Convertible Preferred Stock

In November 2016, the Company completed a private placement of stock in which investors, certain of which are affiliated with the directors and officers of the Company, purchased convertible preferred stock and common stock of the Company (the November 2016 Placement). The Company issued 2,819,549 shares of non-voting Class A Convertible Preferred Stock (the Class A Preferred) at $13.30 per share, each of which is convertible into five shares of common stock upon certain conditions defined in the Certificate of Designation of Preferences, Rights and Limitations of the Class A Preferred filed with the Delaware Secretary of State on November 22, 2016 (the CoD). The Class A Preferred were purchased exclusively by entities affiliated with Redmile Group, LLC (collectively, Redmile). The terms of the CoD prohibited Redmile from converting the Class A Preferred into shares of the Company’s common stock if, as a result of conversion, Redmile, together with its affiliates, would own more than 9.99% of the Company’s common stock then issued and outstanding (the Redmile Percentage Limitation), which percentage could change at Redmile’s election upon 61 days’ notice to the Company to i) any other number less than or equal to 19.99% or (ii) subject to approval of the Company’s stockholders to the extent required in accordance with the NASDAQ Global Market rules, any number in excess of 19.99%. On May 2, 2017, the Company’s stockholders approved the issuance of up to an aggregate of 14,097,745 shares of common stock upon the conversion of the outstanding shares of Class A Preferred. As a result, Redmile has the right to increase the Redmile Percentage Limitation to any percentage in excess of 19.99% at its election. The Company also issued 7,236,837 shares of common stock at $2.66 per share as part of the November 2016 Placement. Gross proceeds from the November 2016 Placement were $56.7 million, and after giving effect to costs related to placement, net proceeds were $54.9 million.

The rights of the Class A Preferred issued in November 2016 are set forth in the CoD. The Class A Preferred are non-voting shares and have a stated par value of $0.001 per share and are convertible into five shares of the Company’s common stock at a conversion price of $2.66 per share, which was the fair value of the Company’s common stock on the date of issuance. Holders of the Class A Preferred have the same dividend rights as holders of the Company’s common stock. Additionally, the liquidation preferences of the Class A Preferred are pari passu among holders of the Company’s common stock and holders of the Class A Preferred, pro rata based on the number of shares held by each such holder (treated for this purpose as if the Class A Preferred had been converted to common stock).

The Company evaluated the Class A Preferred for liability or equity classification under ASC 480, Distinguishing Liabilities from Equity, and determined that equity treatment was appropriate because the Class A Preferred did not meet the definition of the liability instruments defined thereunder for convertible instruments. Specifically, the Class A Preferred are not mandatorily redeemable and do not embody an obligation to buy back the shares outside of the Company’s control in a manner that could require the transfer of assets. Additionally, the Company determined that the Class A Preferred would be recorded as permanent equity, not temporary equity, based on the guidance of ASC 480 given that they are not redeemable for cash or other assets (i) on a fixed or determinable date, (ii) at the option of the holder, and (iii) upon the occurrence of an event that is not solely within control of the Company.

The Company has also evaluated the Class A Preferred in accordance with the provisions of ASC 815, Derivatives and Hedging, including the consideration of embedded derivatives requiring bifurcation from the equity host. Based on this assessment, the Company determined that the conversion option is clearly and closely related to the equity host, and thus, bifurcation is not required.

The issuance of convertible preferred stock could generate a beneficial conversion feature (BCF), which arises when a debt or equity security is issued with an embedded conversion option that is beneficial to the investor (or in-the-money) at inception because the conversion option has an effective strike price that is less than the market price of the underlying stock on the commitment date. The Class A Preferred have an effective conversion price of $2.66 per common share, which was equal to the market price of the Company’s stock on the commitment date. Therefore, no BCF is present.

The Company also entered into a registration rights agreement (the Registration Rights Agreement) with certain of the purchasers in the November 2016 Placement, excluding those purchasers affiliated with the Company’s directors and officers, requiring the Company to register for the resale of the relevant shares. The Company registered all of the relevant shares issued in the November 2016 Placement for resale on a Form S-3 filed with the SEC, as required under the Registration Rights Agreement, and the registration statement was declared effective in January 2017.

Description of Securities

Dividends

As of December 31, 2017, the Board of Directors of the Company has not declared any dividends.

2007 Equity Incentive Plan, 2013 Stock Option and Incentive Plan, and Inducement Equity Plan

The Company adopted an Equity Incentive Plan in 2007 (the 2007 Plan) under which, as amended in August 2013, 2,423,072 shares of common stock were reserved for issuance to employees, nonemployee directors and consultants of the Company. The 2007 Plan provides for the grant of incentive stock options, non-statutory stock options, rights to purchase restricted stock, stock appreciation rights, dividend equivalents, stock payments, and restricted stock units to eligible recipients. In connection with the issuance of restricted common stock, the Company maintains a repurchase right where shares of restricted common stock are released from such repurchase right over a period of time of continued service by the recipient. Effective upon the completion of the Company’s IPO, the board of directors determined not to grant any further awards under the 2007 Plan.

On August 28, 2013, the Company’s board of directors and stockholders approved and adopted the 2013 Stock Option and Incentive Plan (the 2013 Plan and collectively with the 2007 Plan, the Plans). The 2013 Plan became effective immediately prior to the Company’s IPO. Under the 2013 Plan, the Company may grant stock options, stock appreciation rights, restricted stock, restricted stock units and other awards to individuals who are then employees, officers, directors or consultants of the Company or its subsidiaries. A total of 1,020,000 shares of common stock were initially reserved for issuance under the 2013 Plan, and in May 2017, stockholders approved an additional 2,500,000 shares of common stock for issuance under the 2013 Plan. The shares issuable pursuant to awards granted under the 2013 Plan will be authorized, but unissued shares. The shares of common stock underlying any awards from the 2013 Plan and the 2007 Plan that are forfeited, cancelled, held back upon exercise or settlement of an award to satisfy the exercise price or tax withholding, reacquired by us prior to vesting, satisfied without any issuance of common stock, expire or are otherwise terminated (other than by exercise) under the 2013 Plan and the 2007 Plan will be added back to the shares of common stock available for issuance under the 2013 Plan.

In addition, the number of shares of stock available for issuance under the 2013 Plan will be automatically increased each January 1 by 4% of the outstanding number of shares of the Company’s common stock on the immediately preceding December 31 or such lesser number as determined by the compensation committee of the Company’s board of directors.

Recipients of stock options under the Plans shall be eligible to purchase shares of the Company’s common stock at an exercise price equal to no less than the estimated fair value of such stock on the date of grant. Under the Plans, stock options generally vest 25% on the first anniversary of the original vesting date, with the balance vesting monthly over the remaining three years, or vest monthly over four years, unless they contain specific performance and/or market-based vesting provisions. The maximum term of stock options granted under the Plans is ten years.

Restricted stock units under the 2013 Plan generally vest 50% on the second anniversary of the grant date, and 50% on the fourth anniversary of the grant date.

Inducement Plan

On May 10, 2016, the Company’s board of directors approved the Fate Therapeutics, Inc. Inducement Equity Plan (the Inducement Plan), the purpose of which is to enable the Company to grant equity awards to induce highly-qualified prospective officers and employees who are not employed by the Company to accept employment with the Company. Under the Inducement Plan, the Company may grant non-qualified stock options and restricted stock units. A total of 500,000 shares of common stock were initially reserved for issuance under the Inducement Plan, and in January 2018 an additional 400,000 shares of common stock were reserved for issuance under the Inducement Plan. The shares of common stock underlying any awards from the Inducement Plan that are forfeited, cancelled, held back upon exercise or settlement of an award to satisfy the exercise price or tax withholding, reacquired by us prior to vesting, satisfied without any issuance of common stock, expire or are otherwise terminated (other than by exercise) under the Inducement Plan will be added back to the shares of common stock available for issuance under the Inducement Plan.

Employee Stock Purchase Plan

On September 13, 2013, the Company’s board of directors approved and adopted the 2013 Employee Stock Purchase Plan (the ESPP). A total of 729,000 shares of common stock were initially reserved for issuance under the ESPP. In addition, the number of shares of stock available for issuance under the ESPP will be automatically increased each January 1, beginning on January 1, 2015, by the lesser of (i) 2% of the outstanding number of shares of the Company’s common stock on the immediately preceding December 31, (ii) 450,000 shares, or (iii) such lesser number as determined by the compensation committee of the Company’s board of directors.

No purchases have been made to date under the ESPP.

Stock Options and Restricted Stock Unit Awards

Stock Options. The following table summarizes stock option activity and related information under all equity plans for the years ended December 31, 2017, 2016 and 2015:

	Options			Weighted Average Exercise Price Per Share		Weighted Average Remaining Contractual Term		Aggregate Intrinsic Value (in 000s)
Outstanding at December 31, 2014		2,425,969		$	3.83		8.06	$	4,839
Granted		1,345,744			5.23
Exercised		(227,215	)		1.85
Cancelled		(957,024	)		4.20
Outstanding at December 31, 2015		2,587,474		$	4.59		6.92	$	1,486
Granted		2,245,240			2.62
Exercised		(136,368	)		1.44
Cancelled		(785,996	)		3.58
Outstanding at December 31, 2016		3,910,350		$	3.77		8.28	$	682
Granted		2,522,920			3.09
Exercised		(83,220	)		2.79
Cancelled		(892,007	)		3.50
Outstanding at December 31, 2017		5,458,043		$	3.52		7.99	$	14,754
Options vested and expected to vest at December 31, 2017		5,300,033		$	3.53		8.02	$	14,267
Options exercisable at December 31, 2017		2,479,556		$	3.92		7.16	$	5,972

As of December 31, 2017, 2016 and 2015, the outstanding options included 73,600, 73,600, and 14,769, respectively, of performance-based options for which the achievement of the performance-based vesting provisions was determined not to be probable. The aggregate grant date fair value of these options at December 31, 2017, 2016 and 2015, was $0.1 million, $0.1 million and $0.1 million, respectively.

For the years ended December 31, 2017, 2016, and 2015, the Company granted its employees and directors 2.5 million, 2.2 million and 1.2 million stock options, respectively, at a weighted-average grant date fair value per share equal to $2.29, $1.80 and $3.54, respectively.

As of December 31, 2017, 2016 and 2015, the unrecognized compensation cost related to outstanding options (excluding those with unachieved performance- based conditions) was $5.8 million, $4.9 million and $3.8 million, respectively, which was expected to be recognized as expense over approximately 2.6 years, 2.6 years and 2.8 years, respectively.

The total intrinsic value, which is the amount by which the exercise price was exceeded by the price of the Company’s common stock on the date of exercise, of stock options exercised during the year ended December 31, 2017 was $0.1 million. Total cash received upon the exercise of stock options was $0.2 million for the year ended December 31, 2017.

Restricted Stock Units. The following table summarizes Restricted Stock Unit activity and related information under all equity plans for the years ended December 31, 2017, 2016 and 2015:

	Number of Restricted Stock Units			Weighted Average Grant Date Fair Value Per Share		Weighted Average Remaining Vesting Period		Aggregate Intrinsic Value (in 000s)
Outstanding at December 31, 2014		—		$	—		—	$	—
Granted		525,250			4.89
Vested		—			—
Cancelled		—			—
Outstanding at December 31, 2015		525,250		$	4.89		3.80	$	1,770
Granted		—			—
Vested		—			—
Cancelled		—			—
Outstanding at December 31, 2016		525,250		$	4.89		2.80	$	1,318
Granted		—			—
Vested		(225,125	)		4.89
Cancelled		(87,500	)		4.89
Outstanding at December 31, 2017		212,625		$	4.89		1.80	$	1,299
Restricted Stock Units expected to vest at December 31, 2017		212,625		$	4.89		1.80	$	1,299

As of December 31, 2017, 2016, and 2015, the unrecognized compensation cost related to outstanding restricted stock units was $0.9 million, $1.8 million, and $2.4 million respectively, which was expected to be recognized as expense over approximately 1.8 years, 2.8 years, and 3.8 years respectively.

Stock-Based Compensation Expense

The allocation of stock-based compensation for all stock awards is as follows (in thousands):

	Years Ended December 31,
	2017		2016		2015
Research and development	$	2,095	$	1,802	$	1,241
General and administrative		1,511		1,382		1,159
Total stock-based compensation expense	$	3,606	$	3,184	$	2,400

Employee Stock Option Grants. The weighted-average assumptions used in the Black-Scholes option pricing model to determine the fair value of the employee stock option grants were as follows:

	Years Ended December 31,
	2017			2016			2015
Risk–free interest rate		2.0	%		1.6	%		1.6	%
Expected volatility		90	%		80	%		81	%
Expected term (in years)		6.0			6.0			6.0
Expected dividend yield		0.0	%		0.0	%		0.0	%

Risk-free interest rate. The Company bases the risk-free interest rate assumption on observed interest rates appropriate for the expected term of the stock option grants.

Expected dividend yield. The Company bases the expected dividend yield assumption on the fact that it has never paid cash dividends and has no present intention to pay cash dividends.

Expected volatility. Due to the Company’s limited operating history and lack of company-specific historical or implied volatility, the expected volatility assumption is based on historical volatilities of a peer group of similar companies whose share prices are publicly available. The peer group was developed based on companies in the biotechnology industry.

Expected term. The expected term represents the period of time that options are expected to be outstanding. As the Company does not have sufficient historical exercise behavior, it determines the expected life assumption using the simplified method, which is an average of the contractual term of the option and its vesting period.

Non-Employee Stock Option Grants. The weighted-average assumptions used in the Black-Scholes option pricing model to determine the fair value of the non-employee stock option grants were as follows:

	Years Ended December 31,
	2017			2016			2015
Risk–free interest rate		2.1	%		1.5	%		0.8	%
Expected volatility		87	%		83	%		72	%
Expected term (in years)		8.5			6.4			2.7
Expected dividend yield		0.0	%		0.0	%		0.0	%

Warrants to Purchase Common Stock in Connection with Debt Issuance

As a result of the financing of the Loan Amendment on July 14, 2017, the Company issued SVB fully-exercisable warrants to purchase an aggregate of 91,463 shares of the Company’s common stock at an exercise price of $3.28 per share. The warrants expire in July 2024. See Note 5 of the Notes to the Consolidated Financial Statements for additional information on the debt issuance.

The fair value of the warrants was determined to be $0.2 million, which was recorded to additional paid-in capital as a debt discount. The weighted- average assumptions used in the Black-Scholes option pricing model to determine the fair value of the warrants issued were as follows:

	As of July 14, 2017
Risk–free interest rate		2.1	%
Expected volatility		88	%
Expected term (in years)		7.0
Expected dividend yield		0.0	%

Common Stock Reserved for Future Issuance

Common stock reserved for future issuance is as follows:

	December 31,
	2017		2016
Common stock warrants		225,756		134,113
Convertible preferred stock (if converted)		14,097,745		14,097,745
Common stock options		5,458,043		3,910,350
Restricted stock units		212,625		525,250
Awards available under the 2013 Plan		3,572,112		760,065
Awards available under the Inducement Plan		100,000		300,000
Employee stock purchase plan		729,000		729,000
		24,395,281		20,456,523