What are share options?
One of Amazon's key leadership principles is that employees take ownership of their work. If you feel like something belongs to you, you’re far more likely to take it seriously. With that same mindset, actual ownership of the company you work for can also be invigorating.
If you want to hire great people, you want to make them feel like they’re part of something bigger than just their role. You want to make them feel like they’re not just being paid to do a job. That is where employee share options come in.
From a marketing perspective, they are great. They tell the world and prospective employees that you want to be amongst the ‘Facebooks’ of this world, that you value and trust your employees to work in the interest of the company as a whole.
As for a share options definition, from a technical perspective, they are a stock (or share) option gives an investor the right, but not the obligation, to buy or sell a stock at an agreed upon price and date.
Should your company have an employee stock plan?
In real terms, stock options only make sense for a company that is looking to either sell for a lot of money or go public. If you’re not aiming for a big exit, then stock options can’t really ever be used, and as such won’t ever be worth anything. From a marketing and recruitment perspective, share options will be much more difficult to pitch as they won’t fit in with the company story. If you’re not trying to build and then sell a huge business for millions at some point in the future, then there are better ways of compensating your employees.
When considering alternatives to stock options, bear in mind that their purpose is to allow your employees to share in the company’s success. A well-designed bonus scheme is one way of providing employees with that extra motivation to hit their targets and help the company thrive. Profit share is a similar notion and makes a lot of sense if the owner of the business isn’t actually planning on ever selling the company.
If you are looking to make a big exit, then the employee share options route is probably the best for you.
Then again, even if you are highly ambitious and planning for a major exit, issuing shares might be an unattractive option simply because it dilutes the stock already owned by the founders and investors. Be warned however, that if that is your only reason for not issuing stocks, then it will be harder to motivate employees to go the extra mile or to attract the very best talent.
There can also be a bit of an admin overhead, though it is getting a lot more straight-forward, in part thanks to companies like Vestd.
As a rule, investors will want you to issue shares to employees. This is because your key stakeholders will always want to be confident that the talent in your team is incentivised. Often, it is even a requirement on term sheets to create an option pool of a certain percentage.
Share options risks and tips:
Share options will often get issued to employees and then not talked about. This leads to a lack of understanding and some confusion. You need to spend time explaining what they are to the employees who will receive them. There is no reason that your employees will have come across stock options before, so they won’t know what value looks like. A big danger is that due to their relatively complexity, it’s all too easy for employees to get false ideas about how much they own. An obvious facet of this is dilution: though you may award an employee 1% of the company at a given date; over time, with more investment being poured into the company, that 1% will become a smaller percentage of the company at a later date. At the same time, the value of that reduced share may also have gone up! If you’re going to pursue the avenue of issuing shares to employees, then commit to it properly. That means that if the company grows and raises more money after some share options have been issued to employees, you must communicate with those employees exactly what those changes mean. It is a painful experience for everyone if a colleague feels deceived over how much they own.
For more on this, you can read our blog on how to explain share options to your employees.
In the UK, Enterprise Management Incentives (EMI) are a very tax-efficient and generous way of implementing a share scheme in your company. They allow employees to take on share options without any tax risks. When the employee then sells said shares, they qualify for entrepreneur’s relief (only 10% tax).
A big problem however, and this is especially true in the UK, is that there haven’t been that many success stories when it comes to stock options. In the US, you can always refer to the remarkable story of Facebook, which, upon going public, made 1000 millionaires. As a result, you then have a thousand people walking around Silicon Valley who have made a significant amount of cash through employee share options. Their experiences will inevitably affect the mind-sets of those they encounter, making it easier to evangelise about share options. In other countries, you don’t see similar levels of success, so there is significantly less rhetoric around the practice. In the UK, for instance, everyone is familiar with bankers’ bonuses, but there hasn’t been a similar breakthrough in the startup space, at least not yet.
If you’re a founder in the UK, be warned that a lot of the advice when it comes to issuing shares that you can find online is targeted at a US audience. There will be many legal and procedural differences, so be sure to consult an expert before you take action on this front.