Published by Programme B
Whether you’re a business owner or startup founder considering giving your employees stock options, or you’re an employee evaluating a job offer, the following are some of the critical things to know about this concept.
What Is An Employee Stock Option?
A company might use different strategies to incentivize new hires or current employees. Cash compensation is what we think of traditionally, but another way to encourage an employee to be productive or take a job with your company is with a stock option.
Stock options are the right to buy shares in a company. Usually, these are paid over a period of time, based on a vesting schedule.
When an employee has a stock option, they’re given a percentage of ownership in the company in the form of shares.
If the company grows, then the employee’s shares go up in value.
The idea is that when a company profits, then their employees also profit.
This creates a sense of loyalty with employees since there is shared ownership.
How Does It Work?
There are mutual benefits for both companies and employees with stock options.
With a stock option contract, what will usually happen is that there’s a date listed when the options begin to vest or when the employee can sell the stock.
The contract will also lay out how many shares that the employee can sell.
For example, a contract between a company and an employee might indicate an employee receives 15,000 shares over five years.
Then, all the shares can be exercised in five years.
There is usually a waiting period before the stock options vest, known as a cliff.
That means that an employee has to work for the company for a certain amount of time before their stock options kick in.
This incentivizes an employee to stay on board, driving retention.
Employee stock options are also known as ESOs.
Options will have an expiration date, and by this time, the options have to be exercised, or they no longer have value.
The options only have value if the stock’s market price is higher than the option’s exercise price.
What Are the Benefits?
Some of the benefits of employee stock options have been touched on above.
First, there may be a big financial benefit for the employee, as in six- or seven-figure profits.
The profits from stock options very easily can and do exceed whatever an employee’s base salary is.
An employee could become a millionaire from just their stock options.
As such, some employees do best to accept stock options instead of receiving a salary at all.
There are downsides, however.
First, startups tend to offer stock options because they aren’t able to pay salaries. If you’re being offered employment at a startup and that company doesn’t perform as expected, you may end up with worthless options.
The company’s stock can also collapse. It could be due to something on the macro level, or it can also be because of a single event affecting the company, like a change in regulations.
The employer can fail, or you could be terminated before vesting.
Why Is it Smart For a Company To Offer Stock Options?
When a company offers stock options, the appealing feature is that it doesn’t cost them money. Again, if you’re an employer you could potentially offer employees a lower salary for more equity upside. You may have limited resources, especially if you’re a startup.
Compensation can be a considerable expense, but if you can shift things around with stock options, you may be able to retain more cash to invest in growth or to hire more employees.
Stock options can be a way for you to make sure you’re utilizing your cash in the most efficient ways possible.
Stock options can dilute the value of your stock, which is a downside to consider.
Also, it could contribute to executives making riskier decisions than they would have otherwise, to give the stock price a boost.
Overall, stock options are a good way for companies to cultivate loyalty with their employees and improve productivity and output. They can motivate a lot of employees, and they can help with retention, which is a big challenge for many employers.
At the same time, they can lead executives to make decisions that in the short term benefit the stock price but might not be conducive to long-term success.
Whether you’re a business owner or startup founder considering giving your employees stock options, or you’re an employee evaluating a job offer, the following are some of the critical things to know about this concept.
What Is An Employee Stock Option?
A company might use different strategies to incentivize new hires or current employees. Cash compensation is what we think of traditionally, but another way to encourage an employee to be productive or take a job with your company is with a stock option.
Stock options are the right to buy shares in a company. Usually, these are paid over a period of time, based on a vesting schedule.
When an employee has a stock option, they’re given a percentage of ownership in the company in the form of shares.
If the company grows, then the employee’s shares go up in value.
The idea is that when a company profits, then their employees also profit.
This creates a sense of loyalty with employees since there is shared ownership.
How Does It Work?
There are mutual benefits for both companies and employees with stock options.
With a stock option contract, what will usually happen is that there’s a date listed when the options begin to vest or when the employee can sell the stock.
The contract will also layout how many shares that the employee can sell.
For example, a contract between a company and an employee might indicate an employee receives 15,000 shares over five years.
Then, all the shares can be exercised in five years.
There is usually a waiting period before the stock options vest, known as a cliff.
That means that an employee has to work for the company for a certain amount of time before their stock options kick in.
This incentivizes an employee to stay on board, driving retention.
Employee stock options are also known as ESOs.
Options will have an expiration date, and by this time, the options have to be exercised, or they no longer have value.
The options only have value if the stock’s market price is higher than the option’s exercise price.
What Are the Benefits?
Some of the benefits of employee stock options have been touched on above.
First, there may be a big financial benefit for the employee, as in six- or seven-figure profits.
The profits from stock options very easily can and do exceed whatever an employee’s base salary is.
An employee could become a millionaire from just their stock options.
As such, some employees do best to accept stock options instead of receiving a salary at all.
There are downsides, however.
First, startups tend to offer stock options because they aren’t able to pay salaries. If you’re being offered employment at a startup and that company doesn’t perform as expected, you may end up with worthless options.
The company’s stock can also collapse. It could be due to something on the macro level, or it can also be because of a single event affecting the company, like a change in regulations.
The employer can fail, or you could be terminated before vesting.
Why Is it Smart For a Company To Offer Stock Options?
When a company offers stock options, the appealing feature is that it doesn’t cost them money. Again, if you’re an employer you could potentially offer employees a lower salary for more equity upside. You may have limited resources, especially if you’re a startup.
Compensation can be a considerable expense, but if you can shift things around with stock options, you may be able to retain more cash to invest in growth or to hire more employees.
Stock options can be a way for you to make sure you’re utilizing your cash in the most efficient ways possible.
Stock options can dilute the value of your stock, which is a downside to consider.
Also, it could contribute to executives making riskier decisions than they would have otherwise, to give the stock price a boost.
Overall, stock options are a good way for companies to cultivate loyalty with their employees and improve productivity and output. They can motivate a lot of employees, and they can help with retention, which is a big challenge for many employers.
At the same time, they can lead executives to make decisions that in the short term benefit the stock price but might not be conducive to long-term success.