Giving your team a stake in your company can be a brilliant source of motivation – but only if people actually understand them. To make sure you're getting the best out of them, you need to learn how to talk to your team about options. Here's how you do that.
Options - the most commonly used mechanism to award your employees shares in your company - can seem like a dark art. A black box that nobody fully understands and few members of your team really appreciate. That can be extremely frustrating when every point of equity represents something deeply tangible for you, as the owner of a business. Something that not only represents the financial upside of building a company, but the continued control and ownership of the business you cherish.
It's an extremely common complaint that, in spite of designating large chunks of equity to the team (often worth multiple millions of pounds) very few people really value them. The aim of this piece isn't to discuss the variables involved in creating an options strategy and distributing them: there are plenty of good resources for that – such as these guides from Balderton and Index.
Instead, I’m going to talk about how you can embed options into the DNA of your business so that your team value them. After all, if they're meant to be a tool to retain and motivate your best people, then they need to become more than a couple of signed sheets of paper that gather dust in a drawer.
I started off writing this article drawing from my own experience – but I wanted to push the scope broader. We got in touch with Amanda Parsons, Head of Equity Administration at Carta, to find out about the biggest challenges in this area – and how the best small businesses overcame them.
Options are complicated to understand
I have always taken the view that you can't expect anyone to appreciate something unless they understand it. So what are share options?
Nobody finds options straightforward – even those who consider themselves financially literate. Furthermore, lots of online information around employee options is US-centric (this is true for a lot of startup content). While there are some parallels, there are also specific nuances of the UK scene and tax laws that can make much of what you find online misleading.
“Founders are creative. They want to do things differently. That’s fine – but equity is complex enough as it is. Don’t issue anything so complex you can’t explain it in a minute – because, if your business takes off, you’re going to be explaining it pretty much constantly for the next few years.” - Amanda Parsons
Each time a new team member is issued options, I spend 30 minutes talking through all the key areas of the agreement:
- How an option works and why we issue options as opposed to straight equity
- The EMI scheme and its tax advantages
- The current paper value of the awarded options grant, based on the company's valuation at the last round
- How dilution works over funding rounds, explaining how their "percentage ownership" may go down over time but the value of their potential holding should increase
- How vesting works, and when they can (or are required to) exercise their options
- What happens if they leave the company
- And finally - the most important one - the preference stack, which is the leading cause of the second big issue...
Big money exits where share options become worthless
This is a major problem. There are too many examples of big (often £100m+) exits where employees who have worked through multiple years of vesting, cash them in to receive a big fat nothing (or a long stretch short of what they were expecting). We've seen this happen numerous times over the last few years, often covered extensively by the press. Fanduel was a very high profile recent example in the UK.
This is a massive communication error that arises because founders don't communicate the impact of their preference stack to employees. It's extremely standard for venture capitalists to protect their downside through preference shares, and this can have a tangible impact on the value of options even in a big exit. If you’re unsure about preferences, learn all about them here.
I believe it's absolutely vital to ensure options holders understand the terms of each financing round. Not just the new share price, but also the hurdle to clear before those options become worth anything. Set expectations well, and it will ensure that everyone understands what their payday looks like under different circumstances.
Option grants become forgotten
You often award options when a team member joins (or very soon after) and, save for perhaps a grant refresh further down the line, they never need to rear their heads until an exit. That means there are very few reminders of their value – or that they even exist – through the long hard years of grinding away to make them worth anything.
A lot of startups just don’t really talk about equity. They mention it to new candidates during the interview process but never clarify anything or follow up later down the line. - Amanda
A few years back, we started doing something that acts as a little reminder. Every month when we send people's payslips, we also send them an email letting them know the number of options they vested that month and their worth. It's a small reminder that your month of hard graft hasn’t just deposited some cash in your bank account, but you’ve also earned the right to a further share in the upside of the company.
Facebook made 1,000 millionaires
Our perennial issue in the UK is the lack of big success stories. It's reported that Facebook's IPO made more than 1,000 people millionaires as their options grants became valued on the public markets. That's a lot of employees who suddenly have deep pockets to flaunt about town and demonstrate that options really can come good.
Other than continue to work hard to build more great companies on this side of the pond, there is, perhaps, little we can do. It’s helpful to remind the team of stories in the US, but very soon I hope we will start to create our own. Maybe you’ll be one of them?