Stock-Based Compensation

9 Months Ended

Sep. 30, 2021

Share-based Payment Arrangement [Abstract]

Stock-Based Compensation

13. Stock-Based Compensation

Stock-based compensation expense is recognized in cost of revenues, corporate, technology and production systems, and selling, general, and administrative expense in the accompanying unaudited condensed consolidated statements of operations and comprehensive loss as follows (in thousands):

	Three Months Ended September 30,				Nine Months Ended September 30,
	2020		2021		2020		2021
Stock-based compensation expense
Cost of revenues	$	—	$	937	$	—	$	958
Corporate technology and production systems		—		1,449		—		1,487
Selling, general and administrative		570		23,196		1,756		24,791
Total stock-based compensation expense	$	570	$	25,582	$	1,756	$	27,236

Prior to the IPO, all share-based awards were issued to employees under the Company’s 2015 Long-Term Equity Incentive Plan (the “2015 Plan”). Upon the adoption of the Sterling Check Corp. 2021 Omnibus Incentive Plan (the “2021 Equity Plan”) on August 4, 2021 and as of September 22, 2021, all share-based awards are now issued under the 2021 Equity Plan.

2015 Long-Term Equity Incentive Plan

The Company’s 2015 Plan made available for grant 7,068,200 shares of common stock in the form of non-qualified stock options, stock appreciation rights, shares of restricted stock, restricted stock units, performance shares and performance units (collectively, service-based awards) to non-employee directors, officers, employees, advisors and consultants selected by the Company’s Compensation Committee of the Board of Directors for participation in the 2015 Plan. The 2015 Plan, as amended, also made available 3,215,432 performance-based stock options (“PSOs”) to senior executives and directors of the Company, which would only vest upon a change in control or public offering. The 2015 Plan provided for accelerated vesting of outstanding service-based vesting stock options (“SVOs”) in the event of a change in control and provided for accelerated vesting of PSOs in the event of a change in control or an initial public offering and included nondiscretionary anti-dilution provisions in the event of an equity restructuring.

On August 4, 2021, the Company amended each option outstanding under the 2015 Plan to (i) accelerate vesting upon an initial public offering and (ii) permit each option to be exercised following termination for any reason for the period set forth in the applicable award agreement or, if longer, an extended post-termination exercise period that would end on the date that is six months following the second anniversary of the effective date of the initial public offering, provided that if such date falls during a blackout period, the post-termination exercise period will be extended until the date that is thirty days after the commencement of the Company’s next open trading window. In connection with the option agreement amendments, the option holders agreed that any shares of common stock acquired by such individuals upon exercise of any options outstanding under the 2015 plan (the “LTIP Option Shares”) will be subject to the following transfer restrictions, in addition to any other lock-up restrictions, securities trading policies, and other limitations to which such individuals may be subject: (i) the holder will be able to transfer up to 25% of the LTIP Option Shares at any time after six months following the effectiveness of the registration statement of which the IPO Prospectus formed a part (or such earlier time as the transfer restrictions expire under the lock-up agreements described in the IPO Prospectus under “Shares Eligible for Future Sale—Lock-up Agreements”) but prior to the first anniversary of the effectiveness of the registration statement of which the IPO Prospectus formed a part; (ii) on or after the first anniversary but prior to the second anniversary of the effectiveness of the registration statement of which the IPO Prospectus formed a part, the holder
will be able to transfer up to 50% of the LTIP Option Shares (reduced by any of the LTIP Option Shares sold prior to the first anniversary) and (iii) on or after the second anniversary of the effectiveness of the registration statement of which the IPO Prospectus forms a part, the holder will be able to transfer all of his or her LTIP Option Shares. The foregoing transfer restrictions will not apply to any shares of common stock held by any such individual that are not LTIP Option Shares.

Stock Options

As of September 30, 2021, there were 6,450,978 SVOs outstanding and 3,096,830 PSOs outstanding. Under the 2015 Plan, SVOs and PSOs were granted with an exercise price equal to an implied share price of a share of common stock on the date of grant and had a contractual term of ten years. SVOs became exercisable over a five-year period with 60% vesting after three years and the remaining balance becoming equally vested with respect to 20% on each of the fourth and fifth year anniversaries from the date of grant. PSOs became exercisable upon a change in control or an initial public offering. All options granted were subject to continued employment on the vesting date. Upon completion of the IPO, all outstanding SVOs and PSOs under the 2015 Plan were vested and became exercisable.

The weighted average grant date fair values of SVOs granted during the nine months ended September 30, 2020 and 2021 were $2.21 and $2.32, respectively. The weighted average grant date fair values of PSOs granted during the nine months ended September 30, 2020 was $2.21. There were no PSOs granted in the nine months ended September 30, 2021.

The fair value of each option award was estimated on the date of grant using the Black-Scholes option pricing model. The Company uses an income approach, including a multiple of historical EBITDA adjusted for nonrecurring transactions, for valuing its equity. This approach was selected as a reasonably appropriate method to determine the implied share price of the Company’s common stock, which represented a privately-held business interest prior to the IPO. Assumptions used in determining compensation cost for SVOs granted included the following: (i) expected holding period determined using the mid-point of the contractual term; (ii) the estimate of expected volatility based upon an analysis of the historical volatility of guideline public companies; (iii) the likelihood of additional dividends; and (iv) the risk-free interest rate determined using the Federal Reserve nominal rates for U.S. Treasury zero-coupon bonds with maturities similar to those of the expected holding period of the award being valued. The Company uses actual data to record forfeitures.

In November 2020, the Company modified the exercise price of 4,109,140 previously awarded SVOs and 1,483,124 previously awarded PSOs, which impacted 51 employees, modifying the exercise price to $9.68 which represents the share price valuation on the date of modification. The additional cost related to the modification of the exercise price of the SVOs in 2020 was to be recognized on a straight-line basis over the vesting period of the modified awards. The modification did not have a material impact on the Company’s financial statements. All unrecognized stock-based compensation expense related to this modification was accelerated on the date of the IPO as all outstanding SVOs and PSOs vested in connection with the IPO.

The following tables represent the weighted-average assumptions used to determine compensation costs and grant-date fair values for SVOs and PSOs granted during the nine months ended September 30, 2020 and 2021:

	Three Months Ended September 30,						Nine Months Ended September 30,
	2020			2021			2020			2021
Expected volatility		20.83	%		25.90	%		20.38	%		25.90	%
Risk-free interest rate		1.06	%		0.60	%		1.14	%		0.60	%
Dividend rate		0.00	%		0.00	%		0.00	%		0.00	%
Expected term, in years		5.00			5.00			5.00			5.00

The table below provides a summary of SVO and PSO activity under the 2015 Plan for the periods presented (in thousands, except shares and per share amounts):

	Outstanding SVOs									Outstanding PSOs
	Number of Shares			Weighted Average Exercise Price		Weighted Average Remaining Contractual Life (years)		Aggregate Intrinsic Value		Number of Shares			Weighted Average Exercise Price		Weighted Average Remaining Contractual Life (years)		Aggregate Intrinsic Value
Balances as of December 31, 2019		5,374,486		$	9.97		7.83	$	4,700		3,036,930		$	10.38		9.02	$	1,351
Granted		723,615			10.73						143,760			—
Forfeited / Cancelled		(303,650	)		9.99						(59,900	)		—
Exercised		(143,760	)		8.35				356		—			—
Balances as of September 30, 2020		5,650,691		$	10.10		7.55	$	845		3,120,790		$	10.39		8.30	$	—
Balances as of December 31, 2020		6,289,248		$	9.60		7.58	$	843		3,120,790		$	10.05		8.05	$	—
Granted		316,272			9.68						—			—
Forfeited / Cancelled		(148,552	)		9.63						(23,960	)		9.68
Exercised		(5,990	)		9.39				141		—			—
Balances as of September 30, 2021		6,450,978		$	9.58		6.97	$	105,668		3,096,830		$	10.05		7.31	$	31,122

The following table summarizes exercisable SVOs (in thousands, except shares and per share amounts):

	Number of Shares		Weighted Average Exercise Price		Weighted Average Remaining Contractual Life (years)		Aggregate Intrinsic Value
Exercisable as of September 30, 2020		1,007,113	$	8.89		5.08	$	811
Exercisable as of September 30, 2021		6,450,978		9.58		6.97		105,668

The following table summarizes exercisable PSOs (in thousands, except shares and per share amounts):

	Number of Shares		Weighted Average Exercise Price		Weighted Average Remaining Contractual Life (years)		Aggregate Intrinsic Value
Exercisable as of September 30, 2020		—	$	—		—	$	—
Exercisable as of September 30, 2021		3,096,830		10.05		7.31		31,122

The total intrinsic value of SVOs exercised during the nine months ended September 30, 2020 and 2021 was $0.4 million and $0.1 million, respectively.

As of September 30, 2021, there was no unrecognized compensation cost related to SVOs and PSOs as all unrecognized compensation expense totaling $14.9 million was recognized upon the accelerated vesting of options upon completion of the IPO.

Promissory Notes

In December 2020, the Company issued 370,182 shares of common stock to employees at $9.68 per share. Consideration was made in the form of promissory notes between the employee and the Company. The promissory notes accrued interest at the mid-term applicable federal rate for November 2020 (0.39% per annum) and were partially secured by the underlying shares of common stock. The promissory notes were partial-recourse, but treated as nonrecourse for accounting purposes and, as such, (i) each of these purchases of common stock with a promissory note was accounted for as if it were a stock option grant and (ii) no receivable for amounts due under the promissory notes was recorded on the Company’s unaudited condensed consolidated balance sheets. As the shares were considered fully vested, unexercised stock options, the full amount of stock compensation expense was recognized on the grant date in the amount of $0.8 million in 2020. As the employees have the right to require the Company to purchase all of the shares at fair market value under certain events, these instruments were classified as a liability and recorded in Other liabilities on the unaudited condensed consolidated balance sheets as of December 31, 2020. The fair value of the fully vested stock options was marked to market each reporting period.

The promissory notes were forgivable upon (i) a change in control or (ii) the first public filing of a registration statement with the SEC in connection with an initial public offering. On August 4, 2021, the Company approved the forgiveness and cancellation of the outstanding indebtedness of each promissory note holder prior to the IPO. Loan Forgiveness Agreements were executed and concurrently, the Company agreed to accelerate payment of a portion of each holder’s target bonus opportunity for calendar year 2021 to assist the holder in satisfying the withholding tax obligations with respect to the forgiveness of the promissory notes upon consummation of the IPO. On August 16, 2021, pursuant to the terms of the promissory notes, the principal amount on each loan, together with all accrued and unpaid interest, were forgiven. On August 17, 2021, the forgiveness of the promissory notes by the Company was treated as an option modification, resulting in the recognition of stock compensation expense of $7.7 million which reflected the incremental fair value of the award on the date of forgiveness. As of September 30, 2021, the issuance of common stock pursuant to the forgiveness of the promissory notes is classified as Stockholders’ Equity on the unaudited condensed consolidated balance sheets.

2021 Omnibus Incentive Plan

On August 4, 2021, the Company’s Board of Directors adopted, and on August 13, 2021 the Company’s stockholders approved, the 2021 Equity Plan. Equity awards under the 2021 Equity Plan are intended to retain and motivate our officers and employees, consultants and non-employee directors and to promote the success of the Company’s business by providing such participating individuals with a proprietary interest in the performance of the Company. The 2021 Equity Plan will terminate on the tenth anniversary thereof, unless earlier terminated by the Board of Directors. Under the 2021 Equity Plan, the following types of awards can be granted to an eligible individual (as defined by the plan and to the extent permitted by applicable law): incentive stock options (or “ISOs”) and nonqualified stock options (or “NQSOs”); stock appreciation rights (or “SARs”); restricted stock; restricted stock units (or “RSUs”); performance awards; cash-based awards and other share-based awards. Subject to any adjustment as provided in the 2021 Equity Plan, up to 9,433,000 Shares may be issued pursuant to awards granted under the 2021 Equity Plan (the “Share Limit”); provided, that, the Share Limit shall be automatically increased on the first day of each calendar year commencing on January 1, 2022 and ending on January 1, 2030 in an amount equal to the lesser of (x) 5% of the total number of shares outstanding on the last day of the immediately preceding calendar year, and (y) such number of shares as determined by the Board of Directors, and no more than 9,433,000 shares may be issued upon the exercise of ISOs. As of September 30, 2021, 3,936,751 shares were available for issuance under the 2021 Equity Plan.

On September 22, 2021, the Company made one-time grants to all employees under the 2021 Equity Plan (the “IPO Bonus Grants”). Certain members of its senior management team received IPO Bonus Grants consisting of both a nonqualified stock option grant (the “IPO Bonus Options”) and a restricted stock grant (the “IPO Bonus Stock Awards”). Non-employee directors received a NQSO grant and all other employees were granted a restricted stock grant or a restricted stock unit (the “IPO Bonus Stock Unit Awards”).

Stock Options

In connection with the IPO, the Company granted to executives 3,627,441 shares of common stock to be issuable upon the exercise of options at an exercise price equal to $23.00 per share. These IPO Bonus Options (other than grants to non-employee directors) vest 50% on the second anniversary of the grant date and 25% on each of the third and fourth anniversaries of the grant date, subject to the executive’s continued employment with the Company through the applicable vesting date. Each of the IPO Bonus Options granted to non-employee directors will vest in three substantially equal annual installments on the first three anniversaries of the grant date, subject to the non-employee director’s continued service with the Company through the applicable vesting date. Options issued under the 2021 Equity Plan generally expire ten years after the grant date.

The fair value for IPO Bonus Options granted under the 2021 Equity Plan was estimated at the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions:

Expected volatility	44.53	%
Risk-free interest rate	1.04	%
Dividend rate	0.00	%
Expected term, in years	6.38

The weighted average grant date fair value of the IPO Bonus Options granted during the three and nine months ended September 30, 2021 was $10.24.

Restricted Stock

In connection with the IPO, the Company granted to employees 1,824,597 restricted shares with a grant date fair value of $23.00 per share. These IPO Bonus Stock Awards will vest 50% on the second anniversary of the grant date and 25% on each of the third and fourth anniversaries of the grant date, subject to the employee’s continued employment with the Company through the applicable vesting date. Holders of restricted stock are entitled to all rights of a common stockholder of the Company and are subject to restrictions on transfer. 

Restricted Stock Units

In connection with the IPO, the Company granted to employees 44,211 RSUs with a grant date fair value of $23.00 per share. These IPO Bonus Stock Unit Awards will vest 50% on the second anniversary of the grant date and 25% on each of the third and fourth anniversaries of the grant date, subject to the employee’s continued employment with the Company through the applicable vesting date. Upon vesting, employees will receive shares of common stock in settlement of the units. 

As of September 30, 2021, the Company had approximately $79.7 million of unrecognized pre-tax non-cash share-based compensation expense, comprised of approximately $36.9 million related to NQSOs, $41.7 million related to restricted stock, and approximately $1.0 million related to RSUs, all of which the Company expects to recognize over a weighted average period of 4.0 years.

Employee Stock Purchase Plan

In connection with the IPO, on August 4, 2021, the Board of Directors adopted, and on August 13, 2021 the stockholders approved, the 2021 Employee Stock Purchase Plan (the “ESPP”), which allows eligible employees to voluntarily make after-tax contributions of up to 15% of such employee’s cash compensation for the purchase of the Company’s stock. It is expected that consecutive offering periods of six months in duration will be established during which such contributions will be accumulated and applied to purchase shares at the end of the offering period. It is expected that the purchase price will not be less than 85% of the lesser of the closing price of the shares on the first day of the offering period or the last day of the offering period. There were no stock employee purchase offerings during the three and nine months ended September 30, 2021 and, accordingly, no eligible employees were enrolled in the ESPP during the three and nine months ended September 30, 2021.

The ESPP authorizes the issuance of a total of 1,886,000 shares, which number shall be automatically increased on the first day of each calendar year following the calendar year in which the effective date of the ESPP falls in an amount equal to the lesser of (a) 1% of the total number of shares outstanding on the last day of the immediately preceding calendar year and (b) a lower number of shares as determined by the Board of Directors. Notwithstanding the foregoing, the maximum number of shares that may be issued or transferred under the ESPP shall not exceed an aggregate of 11,319,000 shares.