How to establish, design and implement a stock options program — GEMSᵖᵐ | Computershare (2024)

On a daily basis you’re faced with big decisions to make; business-critical decisions that can make, or break, the growth of your company. While some may be easy to make, others can be a bit more complex. Consider your employees and the decisions you make on their behalf. Your employees are a key factor in the success of your company.

You need top-notch employees who are committed to working hard and providing contributions that make a difference in your business. Decisions around how you attract and retain this top talent are crucial to your success.

Offering stock options to both potential and existing employees is a great way to engage quality candidates, no matter what stage of growth your company is in. With a stock option program, employees are provided an incentive to perform and often perform at a greater level because they recognize that the success of the company means more money in their pocket.

On the start-up front, companies can significantly benefit from preserving capital they may want to reserve for future investments because with stock options a company can offer lower cash compensation up front. Since startups are competing for talent with larger, established companies, you can offer a potentially significant appreciation in the value of the equity.

For the later-stage companies, offering a solid stock option plan makes you a competitive force in the industry as an employer. Experienced professionals will be compelled by your offering and more willing to make a move to be part of your team.

What’s the plan (no pun intended)

Determining the purpose of your plan, including goals and eligibility needs to be the first step. You’ll want to think about the type of plan you’ll offer, to whom you will be offering it to, the ultimate goals of the plan, and what eligibility requirements will be for employees. This is a lot to consider but understanding and defining these parameters upfront is necessary.

The reality is that once you create a plan your employee participants will have many questions around what’s being offered. You’ll need to be prepared and educated in order to answer every question that comes your way.

Establish a budget and strategy

Offering a stock option plan of any kind will cost money. Costs are most typically associated with administration, communications, and execution of your plan. You’ll need to consider all of these early on ensuring you are positioning yourself to financially afford what you offer.

How you administer your plan is completely up to you. Will you use a software solution? Will you hire a team of individuals to manage your plan? You’ll need experts in place to handle the expensing of the plan and any other financial obligations that come along with it. You’ll want to be cost effective, but you also need to ensure your stock options are maintained accurately and administered correctly to avoid unforeseen fines and penalties that as a new company you simply can’t afford.

You’ll need to communicate and educate your employees about the plan you offer. You’ll need to think about what, when and how you want to keep your employee participants informed about the plan because engagement is key. Having the ability to communicate to and educate your employees as your grow is crucial to your plans’ success.

Understand your options (see what we did there)

There are several components to think about when designing your plan. First and foremost, understanding the types of stock option plans available to you and knowing the benefits of each are critical. Below are the various types of equity compensation types to choose from:

Stock options

The most common stock options include incentive stock options (ISO) and non-qualified stock options (NQSO). Both grant an employee a certain number of shares in company stock which can be purchased on a specific date. With an ISO, the share price is locked at fair market value on the date the option is granted. Whereas a NQSO provides the recipient the option to purchase stock after a set date in the future, but at present-day prices.

Restricted stock units and awards

A restricted stock unit grants the employee company shares without requiring the employee to purchase them based on performance-based metrics being met. A restricted stock award works similarly, however recipients are granted shares based on longevity and loyalty to the company. In either case, restricted stock is not issued until specific and agreed upon criteria is met for the employee.

Performance awards

A performance award is simply tied to specific performance measurements and milestones. The company evaluates the employee’s performance, determines if the criteria were met and decides how many shares to award the recipient. Performance awards can come with an additional vesting period, but the employee would ultimately own the share outright.

Stock appreciation rights

Stock Appreciation Rights (SAR), by itself, the recipient’s bonus compensation is based on the increased value of a specific number of shares of company stock. Instead of rewarding the employee with equity, the employee receives the cash equivalent of that increased value. This bonus can also be paid in the form of shares.

Dive right in to option pools

If you haven’t already, you’ll need to establish an option pool. An option pool reserves a block of stock in the very early stages that allows you to offer an equity incentive to future employees, advisors, board members or other stakeholders. With the equity you have set aside in your option pool up front, you are able to give company shares to those most important in the success of your start-up. In doing so you are helping to prevent dilution of existing holders and also altering your ownership structure, both of which need to be tracked on your cap table.

With the right software, all of this gets tracked and maintained in your cap table so that at a moment’s notice you have the ability to produce reports proving your company ownership. And, trust us, whether it’s for an investor, an employee, or a regulator, at one point or another you’ll need this information at the drop of a dime.

Know the legal and regulatory framework

The type of equity incentive you offer, along with the type of payment options and the participants who are offered these incentives will be influenced by various legal, tax and accounting laws as well as legal and regulatory framework. These are things that you don’t want to mess around with because one small error can lead to big fines and penalties. Not to mention the issues your participant might face as a result.

Having a solid understanding of the legal and regulatory requirements up front means you’ll be able to choose a plan that is best fit for your company and your employees. But keep in mind that these requirements can change frequently and will need to be kept up with.

Obtain a 409a valuation

A 409a valuation is defined as an appraisal of the fair market value of your start up’s common stock. It is suggested that a 409a valuation is done when your company intends to offer stock options. Depending on how often your company issues stock options or when a material event occurs determines how often a 409a valuation is needed, however it is typically performed on an annual basis.

But how do you get it done? You have a couple choices – do it yourself, use a software tool, or hire an independent appraiser. Whichever you chose, keep in mind you’ll want to understand the benefits and risks associated with each and you’ll need to provide certain required documentation no matter which route you take. For more on 409a valuations, check out this blog post[SP4].

Key stakeholder approval

Once you’ve developed a strategy and design for your equity compensation plan, you’ll need the proper approvals. Board of director and investor approvals will be required prior to your executing your plan. Beyond just the stock options being approved, your board of directors will also need to approve the employee being issued the award, the number of shares, the vesting schedule and the exercise price. The grant date for tax, legal and accounting purposes becomes the date in which the board of directors approves an issuance. This is important because the grant date is used to determine the exercise price of the option. For example, getting stock option issuance approval sooner, may mean the employee being granted the award can receive, and exercise, at a price that is closest to their employment start date.

Understand the importance of administering your employee plans with software

Using the right software to manage your employee stock options is a pretty important part of your success.In fact, with the right software platform, you’ll be able to focus on what matters – your business and your talent strategy – while being confident that you’re not missing a beat when it comes to your employee stock options. There’s lots of reasons why you should ditch the spreadsheets and make the move to a software solution, but only the right software can help you achieve the top 5 benefits:increased accuracy, benchmarked plan data, risk reduction, more time in your day and amplified employee engagement.

Keep your employees educated and informed

Understanding the complexities of stock options is one thing. Communicating them to your employees is quite another. Chances are you will spend a significant amount of time learning the ins and outs of everything stock option related (as best you can, of course). While your employees don’t necessarily need that level of detail, they do need to understand the plan they are being offered. Here’s a few key things that you’ll want to be sure you communicate to your eligible employees:

• Value and benefits. The obvious reason you are offering stock options is to attract and retain top talent. But that’s the benefit to your company. You’ll want to make sure you position your stock options to employees in a way that proves real value and benefits to the employee. The employee needs to understand the positive impact this can have on their future and it’s your job to stress that message.

• Key terms. You already know that stock options can be complex. Now consider an employee who’s never had options available to them before. Educating your employees on key terms will help ensure they know what their choices are, how to purchase them and the operational basics of stock options.

• Employee responsibilities. Although you are in charge of the stock options, your employees have responsibilities too. Understanding the need for employees to accept grants and how they do that needs to come from you. How they accept grants and access their holdings will also be questions coming your way that you’ll want to be certain you have an answer for.

• Termination options. From retirement to life-changing events, it’s inevitable at one point or another your employees will leave the company. At that point it’s important to help them understand what for the impact is on their stock options.