startup employee stock options

Compensating Early Startup Employees with Stock Options

Companies are very creative when it comes to employee benefits. Some provide their employees with unpaid travel time. Other companies treat them with fitness and wellness club subscriptions, but by far the most desired type of benefit or compensation in the dynamic startup world, are company shares. These are handed out as parts of employee stock ownership, equity compensation, or other, similar plans. Handing out company stocks to employees became a universal practice in Silicon Valley tech companies, one that it is mainly driven by egalitarian engineering culture that runs that place.

Benefits of Handing out Company Stocks

Some entrepreneurs have problems with realizing benefits that these programs can bring. Older tech companies only handed out company stocks to the most important members of the company’s management team. In the meantime, a whole new generation of entrepreneurs incorporated their businesses and realized that employee stock ownership plans take care of the following points:

  • They align the company’s and the employee’s interests;
  • These plans encourage employees to work towards achieving the company’s goals;
  • They reward employees for their work and dedication;
  • Stock ownership can represent a great retirement plan;
  • They decrease absenteeism;
  • They keep the most valuable employees under the company’s umbrella;
  • Employee Ownership Plan (ESOP)

    This is the most popular plan that includes handing out company stocks to employees. It is a type of a retirement plan that invests in the company’s stocks which are kept in a trust. Employees receive dividends, but if they decide to leave the company, in most cases they get paid out for the stocks they own. This means that the company can share the same stocks with newcomers. Most companies that use this type of a plan are listed as S Corporations. Unlike other types of employee equity plans, which usually include giving stocks to most valuable employees, the nature of ESOP denies any type of discrimination in favor of the highly ranked individuals. This means that literally every full-time employee who works more than 20 hours per week needs to receive a part of company’s ownership, even if he/she works for a minimum wage. In this case, ESOP can be used as a special bonus which follows all pros and cons of the minimum wage hike.

    Equity Compensation Plans

    These plans require employees to purchase a company’s stock. In most cases these stocks are offered for sale during a special time period and can be bought at moderate prices. There are different types of equity compensation plans including the following:

  • Employee stock purchase plan (ESPP) – this plan enables an employee to buy the company’s stocks using payroll deductions. Most ESPPs are offering stocks at discounted prices;
  • Restricted stock plan – these plans also offer sale of company stocks to employees, but they usually come with some type of a restriction such as vesting.
  • Phantom stock plans these plans don’t involve handing out or selling company stocks to employees. They include bonuses that directly depend on a company’s stock price, which are shared in the same way as stock dividends, although employees do not get any kind of company ownership.
  • Restricted stock unit plans – these plans are similar to phantom stock plans, but they are based on handing out shares instead of cash bonuses.
  • Stock appreciation rights – these plans rely on bonuses that match increases of a hypothetical stock grant value;
  • Who Should Receive a Company’s Equity?

    Selling company stocks at discounted prices to employees should be fair and transparent. Entrepreneurs should create option pools that will follow company’s needs and growth. These are some of the option pool suggestions:

  • New hires – many different (mostly tech) companies guarantee a small share of company’s equity to new arrivals in order to attract top talents and experts.
  • Employees who get promoted – promotion should bring a certain batch of company stock to an employee in order to motivate the recipient to diligently do their job in a new, more responsible position.
  • Those who show outstanding performance – From 10% up to 20% of the agile and dedicated employees should receive this type of stocks in order to motivate them to continue with the outstanding work and to create an example for others. This group shouldn’t include executives and members of company’s management team.
  • Loyal employees – these grants should be available to all employees who have worked more than 2 and a half years for the company. They should receive these grants on an annual basis.
  • All in all, handing out stocks is a great way to motivate employees. Tech companies that apply some of the mentioned plans and programs usually tend to show outstanding work performance. It also boosts employees’ creativity and makes them think about improving company’s business and public image.

    AUTHOR: James D. Burbank has worked in the trade show industry for more than 15 years and he has seen all kinds of startups succeed and fail for any number of reasons. He is editor in chief at BizzMarkBlog and a one of the rare non-Utahn Utah Jazz fan. James also runs – Bizzmark Blog.