Share-Based Payments

2009 Stock Incentive Plan

The Company maintains the Eleven Biotherapeutics, Inc. 2009 Stock Incentive Plan (the “2009 Plan”), as amended and restated, for employees, directors, consultants, and advisors to the Company. Upon the closing of the Company’s IPO in February 2014, the Company ceased granting stock incentive awards under the 2009 Plan. The 2009 Plan provided for the grant of incentive and non-qualified stock options and restricted stock grants as determined by the Board. Under the 2009 Plan, stock options could not be granted at less than fair value on the date of the grant. Furthermore, the exercise price of incentive stock options granted to an employee, who, at the time of grant, is a 10% shareholder, could not be less than 110% of the fair value on the date of grant.

Terms of stock option agreements, including vesting requirements, are determined by the Board, subject to the provisions of the 2009 Plan. Options and restricted stock awards granted by the Company generally vest ratably over four years, with a one-year cliff for new employee awards, and are exercisable from the date of grant for a period of ten years. Restricted stock issuances and early exercises of stock options are subject to the Company’s right of repurchase at the original issuance price, which right lapses over the vesting period of the stock. For options and restricted stock awards granted to date, the exercise price equaled the estimated fair value of the common stock as determined by the Board on the date of grant.

2014 Stock Incentive Plan

In December 2013, the Company’s 2014 Stock Incentive Plan (the “2014 Plan”) was adopted by the Board and was approved by the Company’s stockholders in January 2014. The 2014 Plan became effective immediately prior to the closing of the Company’s IPO in February 2014. The 2014 Plan provides for the grant of incentive stock options, nonstatutory stock options, restricted stock awards, restricted stock units, stock appreciation rights and other stock-based awards. The number of shares of the Company’s common stock reserved for issuance under the 2014 Plan is the sum of (1) 708,661 shares, plus (2) the number of shares (up to 1,347,821 shares) equal to (a) 1,586 shares (representing the number of shares reserved for issuance under the 2009 Plan that remained available for future issuance as of the effectiveness of the 2014 Plan) and (b) the number of shares of the Company’s common stock subject to outstanding awards under the Company’s 2009 Plan that expire, terminate or are otherwise surrendered, cancelled, forfeited or repurchased without having been fully exercised or resulting in any common stock being issued, plus (3) an annual increase, to be added on the first day of each fiscal year, equal to the lowest of 1,102,362 shares of the Company’s common stock, 4% of the number of shares of the Company’s common stock outstanding on the first day of the applicable fiscal year and an amount determined by the Company’s Board. On January 1, 2016, the Company increased the number of shares reserved for issuance under the 2014 Plan by 786,431 shares. As of December 31, 2016, the total number of shares of common stock available for issuance under the 2014 Plan was 1,088,303.

The Company’s employees, officers, directors, consultants and advisors are eligible to receive awards under the 2014 Plan. However, incentive stock options may only be granted to the Company’s employees.

Inducement Grants

On September 20, 2016, in connection with the Acquisition, the Company granted stock options to purchase 650,000 shares of the Company's common stock. The grants were made in the form of inducement equity awards outside the 2014 Plan in accordance with NASDAQ Listing Rule 5635(c)(4).

These stock options were granted with an effective grant date of September 20, 2016 and an exercise price of $3.37 per share (the closing price per share of the Company's common stock on September 20, 2016) as an inducement to each recipient in connection with his employment. The inducement equity awards were approved and recommended by the Company's Compensation Committee, approved by the Board and were made as an inducement material to each recipient's acceptance of employment with the Company in accordance with NASDAQ Listing Rule 5635(c)(4).

Each of the inducement grants expires on the day preceding the tenth anniversary of the grant date and vests over four years, with 25% of the original number of shares subject to the option vesting on the one year anniversary of the date of grant of the option and an additional 6.25% of the shares subject to the option vesting at the end of each successive three-month period following the one -year anniversary of the date of grant of the option, subject to the recipient's continued service with the Company through the applicable vesting dates.

A summary of the Company’s stock option activity and related information follows:



	Shares		Weighted-Average Exercise Price		Remaining Contractual Life (in years)	Aggregate Intrinsic Value (in thousands)
Outstanding at December 31, 2015	1,803,574		$	6.28	7.78	$	1,540
Granted	1,747,495		1.69
Exercised	(656,532	)	0.41
Cancelled or forfeited	(870,069	)	5.86
Outstanding at December 31, 2016	2,024,468		$	4.41	8.73	$	841
Exercisable at December 31, 2016	1,139,514		$	5.09	8.08	$	779
Vested and expected to vest at December 31, 2016 (1)	1,879,868		$	4.49	8.66	$	834

(1)Represents the number of vested options, plus the number of unvested options expected to vest.

The total intrinsic value of options exercised for the years ended December 31, 2016, 2015 and 2014 was $942,000, $768,000 and $921,000, respectively. The total fair value of employee options vested for the years ended December 31, 2016, 2015 and 2014 was $3.7 million, $1.8 million and $1.3 million, respectively.

Restricted Stock

From time to time, upon approval by the Board, certain employees and advisors have been granted restricted shares of common stock. Certain shares of restricted stock were subject to repurchase rights. Accordingly, the Company recorded the proceeds from the issuance of certain restricted stock as a liability in the consolidated balance sheets. The restricted stock liability was reclassified into stockholders’ equity as the restricted stock vested. A summary of the status of unvested restricted stock as of December 31, 2016 and 2015, and changes during the year ended December 31, 2016 are presented below:



	Restricted Stock		Weighted-Average Grant Date Fair Value
Unvested at December 31, 2015	41,657		$	11.05
Vested	(19,507	)	10.62
Unvested at December 31, 2016	22,150		$	11.43

The Company did not grant restricted stock to non-employees during the year ended December 31, 2016. The Company issued 6,660 shares of restricted stock to non-employees during the year ended December 31, 2015. The non-employee restricted stock is revalued as it vests. There were no shares of non-employee unvested restricted stock outstanding at December 31, 2016. The expense related to the restricted stock granted to non-employees for the years ended December 31, 2016, 2015 and 2014 was $3,000, $45,000 and $58,000, respectively.

Restricted Stock Units

From time to time, upon approval by the Board, certain employees have been granted restricted stock units. A summary of the status of restricted stock units is presented below:



	Restricted Stock Units		Weighted-Average Grant Date Fair Value
Unvested at December 31, 2015	150,932		$	2.85
Vested	(134,499	)	2.83
Cancelled	(13,100	)	2.76
Unvested at December 31, 2016	3,333		$	4.09

The Company did not issue any restricted stock units to non-employees during the years ended December 31, 2016 and 2015 .

Performance-Based Stock Options

The Company has granted stock options to employees and founders of the Company, which contain both performance-based and service-based vesting criteria. Milestone events are specific to the Company’s corporate goals, including but not limited to certain preclinical and clinical development milestones related to the Company’s product candidates. Stock-based compensation expense associated with these performance-based stock options is recognized if the performance condition is considered probable of achievement using management’s best estimates. In 2016, the compensation committee of the Board determined that performance-based milestones were achieved and the Company recorded stock-based compensation of $40,000. There was no expense recorded for performance-based stock options during the year ended December 31, 2015. During the year ended December 31, 2014, management determined that a performance-based milestone was achieved and recorded stock-based compensation expense of $293,000. As of December 31, 2016, there were no performance-based stock options outstanding.

Stock-Based Compensation Expense

The fair value of each stock option granted to employees and directors was estimated on the date of grant using the Black-Scholes option-pricing model based on the assumptions noted in the following table:



	Year Ended December 31,
	2016	2015	2014
Risk-free interest rate	1.23-2.38%	1.42-1.92%	1.67-2.02%
Expected dividend yield	—%	—%	—%
Expected term (in years)	5.5-6	5.75-6	5.75-6
Expected volatility	71.44-73.42%	69.06-74.11%	60.00-69.58%

Volatility

Since the Company has only been publicly traded since February 6, 2014, it does not have relevant historical data to support its expected volatility. As such, the Company has used a weighted-average of expected volatility based on the volatilities of a representative group of publicly traded biopharmaceutical companies. For purposes of identifying representative companies, the Company considered characteristics such as stage of development and area of therapeutic focus. The expected volatility has been determined using a weighted-average of the historical volatilities of the representative group of companies for a period equal to the expected term of the option grant. The Company intends to continue to consistently apply this process using the same similar entities until a sufficient amount of historical information regarding the volatility of the Company’s own share price becomes available or until circumstances change, such that the identified entities are no longer representative companies. In the latter case, more suitable, similar entities whose share prices are publicly available would be utilized in the calculation.

Risk-Free Rate

The risk-free rate is based on the yield curve of U.S. Treasury securities with periods commensurate with the expected term of the options being valued.

Expected Term

The Company uses the “simplified method” to estimate the expected term of stock option grants. Under this approach, the weighted-average expected life is presumed to be the average of the contractual term (ten years) and the vesting term (generally four years) of the Company’s stock options, taking into consideration multiple vesting tranches. The Company utilizes this method due to lack of historical exercise data and the plain-vanilla nature of the Company’s share-based awards.

Dividends

The Company has never paid, and does not anticipate paying, any cash dividends in the foreseeable future, and therefore uses an expected dividend yield of zero in the option-pricing model.

Forfeitures

The Company is also required to estimate forfeitures at the time of grant, and revise those estimates in subsequent periods if actual forfeitures differ from its estimates. The Company uses historical data to estimate pre-vesting option forfeitures and record stock-based compensation expense only for those awards that are expected to vest. To the extent that actual forfeitures differ from the Company’s estimates, the difference is recorded as a cumulative adjustment in the period the estimates are revised. Stock-based compensation expense recognized in the consolidated financial statements is based on awards that are ultimately expected to vest.

Using the Black-Scholes option-pricing model, the weighted-average per share grant date fair values of options granted to employees in 2016, 2015 and 2014 were $1.09, $5.60 and $8.68, respectively. The expense related to the options granted to employees for the years ended December 31, 2016, 2015 and 2014 were $3.3 million, $2.0 million and $1.6 million, respectively.

The Company granted 5,000 stock options to non-employees during the year ended December 31, 2016 with an exercise price of $0.28 per share. The Company did not grant stock options to non-employees during the years ended December 31, 2015 and 2014.

The fair value of each non-employee stock option is valued on grant date and revalued as it vests using the Black-Scholes option-pricing model based on assumptions noted in the following table:



	Year Ended December 31,
	2016	2015	2014
Risk-free interest rate	1.08-2.38%	1.19-2.26%	1.67-2.04%
Expected dividend yield	—%	—%	—%
Expected option life (years)	10	10	10
Expected stock price volatility	69.92-92.09%	67.24-92.40%	57.65-80.98%

There were no non-employee stock options outstanding at December 31, 2016. The expense related to the options granted to non-employees for the years ended December 31, 2016, 2015 and 2014 were $0, $168,000 and $504,000, respectively.

As of December 31, 2016, there was $1.8 million of unrecognized stock-based compensation, net of estimated forfeitures, related to unvested stock option grants which is expected to be recognized over a weighted-average period of 2.9 years.

Employee Stock Purchase Plan

On January 21, 2014, the Board adopted the 2014 Employee Stock Purchase Plan (“2014 ESPP”), which was subsequently approved by the Company's stockholders and became effective upon the closing of the Company’s IPO on February 6, 2014. The 2014 ESPP authorizes the initial issuance of up to a total of 157,480 shares of the Company’s common stock to participating employees. The first offering period under the 2014 ESPP opened on September 15, 2015 and closed on March 14, 2016. On March 14, 2016, the Company issued and sold 20,760 shares of its common stock pursuant to the 2014 ESPP at a purchase price of $0.31 per share. The second offering period under the 2014 ESPP opened on March 15, 2016 and closed on September 14, 2016. On September 14, 2016 the Company issued and sold 68,111 shares of its common stock pursuant to the 2014 ESPP at a purchase price of $0.42 per share. The third offering period under the 2014 ESPP opened on September 15, 2016. The Company has estimated the number of shares to be issued at the end of the third offering period and recognizes expense over the requisite service period. The Company recognized $18,000 during the year ended December 31, 2016 related to the 2014 ESPP.

Acceleration of Equity Awards

In connection with the closing of the Acquisition, certain officers of the Company were terminated and entered into separation agreements with the Company. Under the separation agreements, the Company accelerated in full the vesting of all of their outstanding equity awards consistent with their existing employment agreements. As a result of the acceleration, the Company recognized $1.7 million of stock-based compensation expense. In addition, the Company provided that all stock options granted to Dr. Celniker under the Company’s 2009 Plan shall continue to be exercisable based on her continued service as a non-employee member of the Board. As a result of this modification, the Company recorded $0.1 million of stock-based compensation expense.