How to Offer Employee Stock Options in Your Company

The owners of smaller, high growth potential startups often want to compensate their employees with options to acquire stock in the company. Not only is this a potentially lucrative reward for your hardworking team who has stuck it out through the ups and downs, it can help to significantly enhance employee motivation, engagement and loyalty.

But, like most other things in business (and in life), it has to be approached in the right way. If you would like to create a stock option program in your company, there here are a few things to consider:

First Off, What Are Stock Options?

Options give your employees the right to acquire stock in your company at a future time, at a set exercise or “strike” price. The price your company sets on the stock is typically discounted. Often, companies rely on the market price of the stock at the time the employee is granted the options. In other words, the exercise price cannot be lower than your company’s market value per share at the time of grant. The number of shares available and the time during which employees can exercise their option to buy would also be set by your company from the start of the option. Until your employee exercises the options to purchase actual shares, the employee has none of the rights of a shareholder.

Since the options cannot be exercised right away, if the price of the shares increase over time, then selling them later at a higher market price would yield a profit.

The Benefits of Offering Stock Options to Your Employees

There are several real benefits to having a stock option program in your company:

  • It will help you to attract and retain valuable employees
  • It will help to foster a sense of ownership among your team
  • It can also help to improve motivation since the better your company does, the higher your stock value will be.
  • Finally, this gives you a form of compensation that does not involve cash- which could be helpful if your company is new and needs to preserve as much capital as possible.

What to Consider When Offering a Stock Option Program

Aside from a number of legal issues that are beyond the scope of the article (they will need to be discussed with your lawyer, instead), there are several things to consider before implementing an employee stock option program in your business:

To whom will you offer these options? Stock options are not cheap candy. They need to be given out thoughtfully. Keep in mind, when your employees exercise their option to buy, they are becoming real shareholders in your company. You should primarily be investing in the people that count, the key employees that are indispensable to your business, and then work out from there.

How many shares will you offer? You need to determine each year how much stock you are willing to make available to your employees. This includes factoring in how much you expect your employment to grow in the next few years. If you offer too many options too soon, you may end up with little room for additional options to future employees later on.

Will these options have a vesting period? Depending on your answers to the first two questions above, you may want to factor a vesting period into your stock options. A vesting period is designed to spread out the total number of shares an employee can buy over a specified number of years. So for example, an employee with stock options to buy 200 shares with a five year vesting schedule, would be allowed to buy up to 40 shares a year till the fifth year.

Finally, does your company have real potential growth? Before you create a stock option program in your company, you first have to objectively consider how much potential there is for real, profitable growth. If your company is not successful or growth is slow, then a cash compensation may be a better option for your employees. Since it may be hard for you to look at your business objectively, you should seek the counsel of an outside professional or even a professional mentor.

In short, stock options certainly have their benefits- especially for young, high growth-potential companies. But, you don’t want to just dive into it. The more thought and consideration you give this program, the greater the chances of it being a success.