Startup stock options are confusing. Here are 6 tips.
Entrepreneurs use equity compensation, or stock options, to help build the best team of talent possible to work for their startups. Money is almost always very tight with startups, so stock options serve as a way to make up for less than market value salaries, as well as serve as significant incentive for employees to perform at the highest levels — because the better the companies do, the more money the employees will make.
At the Entrepreneur Bootcamp last week, Employee Equity Compensation: How to Incentivize Your Employees without Burning Through Your Cash, I learned a few tips about startup stock options from presenters Kristine Camron with Ice Miller; Erin Eberly with Katz, Sapper & Miller (KSM); and Tim DuVall with KSM.
Don’t give away your company.
If you can’t afford to hire an attorney or accountant, talk to somebody — a mentor or someone you know who has experience with stock options. One of the biggest issues that arises with stock options is usually during an equity event such as a change of control or major investment, when you discover you have made a big mistake. Often the mistake is in overvaluing the company or arbitrarily assigning stock, but there are plenty of ways to mess up with stock options, so get some help at the beginning so you don’t derail your sale or investment opportunity later down the road.
You don’t have to give stock options to everybody.
Of course, you can’t discriminate based on race, gender, religion or any other protected class, but you can discriminate based on employee class. For example, you should offer equity incentives to key employees like software developers and project managers, but perhaps a bonus structure or something else would be more appropriate for support staff such as administrative assistants and entry-level workers.
Keep it simple.
Just because there are a variety of stock options that serve different purposes, you don’t have to offer every kind. Find the type of stock that best fits the needs of your company and stick with that. Kristine Camron mentioned that more often than not, she chooses Profits Interest Stock Options for her startup clients — for use with partnerships and LLCs. The more options you offer the more chances you have of making a big mistake that could cost you later.
Understand it so you can sell it.
You are going to be using stock options as a way of building your team and incentivizing them. If your sales pitch is “we also offer stock options and it’s pretty complicated,” you aren’t going to get very far. Learn everything you need to know about the stock options you decide to offer and then come up with the best way to communicate this complex topic to your employees. You should be able to have a frank and simplified conversation about the stock options you offer with anybody participating in the plan.
Create a written stock options plan.
Create it and then stick to it. Your stock options written plan should include things like a.) who is eligible for stock options, b.) what is the established pool of options, c.) What are the terms of grant, such a vesting, pricing and timing of payments, and d.) what method is being used to value the company.
Have the plan and pool in place before you raise money.
It’s only going to get more complex and harder to sort out as you add more money and more investors to the mix. Take the time needed to have your stock options plan and operations in place before you start any serious fundraising effort. Not only will this save you from headaches later, it also puts investors at ease that you are proactive and thoughtful in the way you run your business. A complicated or messy issue with stock options could kill a potential investment.
The following presentation is much more detailed including the various types of equity options, what to look out for with each, and how the tax is treated. As the headline declares, stock options are confusing, so seek help from someone knowledgeable you trust or hire a professional.
What questions do you have about stock options?
Please use the comments section below and we will invite our friends at KSM and Ice Miller who presented to address everything they can here on the blog.