Would offering stock option plans to your key employees or executives be beneficial to your business?
Attract Top Talent
A short answer to this question is that offering your employees or executives stock option plans is one way to attract top talent with the offer of less cash payment now, for more payment later.
This is especially important for pre-revenue start-up companies since all their costs of operation come from capital investment or borrowing, until they begin generating revenue. This pre-revenue period is often referred to as the cash burn rate.
Cash Burn Rate
The cash burn rate is exactly as it sounds, it’s the rate at which money is being spent.
The cash burn rate is calculated in a pre-revenue company in order to give some idea as to the rate at which investors’ money is being spent.
The cash burn rate can then be measured against the business’s progress towards the stated objectives that must be met before proceeding to the next round of financing.
The Benefit of Offering a Stock Option Plan
A stock option plan as part of the compensation package for key employees can be a very effective way to minimize the cash burn rate as you work towards your next round of financing.
How Do Stock Option Plans Work?
Basically, the employee is granted an option which vests after a certain period.
Vesting periods matching the expected length of the project which employee is working on are attached to the exercise rights of the stock options.
This gives the employee the right to purchase shares in the company for a pre-determined price, usually based on the value of the company at the start of the project.
By offering the stock option to an employee you tie the overall success of the company and the employee’s performance to the employee’s compensation.
This is because the employee will only exercise their option to purchase the shares if the value of the shares is greater than the purchase option.
Important Things to Note
In order for a stock option plan to be an effective strategy there should be a reporting structure in place.
The employee should have a degree of influence over the success of the business as well as some control over outcomes, or they will become frustrated and lose interest in waiting until the end of the vesting period.
How Much Should You Offer?
Once you have decided to a offer stock option plan to key individuals within your company you will need to decide what percentage you will offer.
While every business is different, for a stock option plan for a key employee, such as part of your executive team, 1-5% would not be unreasonable.
When offering a stock option plan for non-executive key staff, offer much less than 1% as a general rule.