Does Your Stock Option Plan Stack Up?
The 13th in a series of blogs on launching, growing and ultimately selling a technology company, with a corporate finance focus. Topics include cap structures, equity plans, financing, corporate partnering, board matters and how to achieve a successful exit.
So you’ve put your stock option plan in place. Have you figured out the details on who gets the goodies, why, and on what terms?
Deciding who gets options
Even though option plans are often referred to as employee option plans (or ESOPs), it is typical to use the pool to compensate more than just your employees. Options can be a valuable incentive and create alignment around all of those associated with building your company.
Options are used to compensate board members and advisory board members, and even part-time consultants in addition to the employees. The critical item is to do some planning on how to allocate options in order to avoid the disastrous situation of running out — using up the pool to compensate only a portion of the team, or running out of options as you grow and add team members.
I recommend building a grid separating out an allocation of options for four broad groups:
- employees and consultants
- board members
- advisory board members
- a contingency bucket
The lion’s share will be set aside for the first group, employees and consultants. It’s important to take some time in determining how many options you will need for this group, not just today but as you add to your team over the next one to two years.
Start by segregating the employees into levels so that you can do an allocation of options to employees at each level in the organization. You may have as many as four to eight levels defined within the company:
- C-class officers
- supporting team members
- admin staff
- board members
- advisory board members
- a contingency reserve of at least 10% to 15% of the overall pool
The reasoning behind option allocations
Generally speaking the founders (even though they will be employees and senior officers) will not take options (or at least not in the early stages of the company) as their founders’ shares will be their equity compensation. And if they are on the board, they don’t usually take options as board members either. Down the road this can change because as the company dilutes and the years go by, it may make sense to top up the founders with options.
With respect to the employee and consultants group there are two schools of thought:
- options for all to create alignment, build an inclusive culture and reward everyone; or
- options only to senior members of the team.
The theory behind the latter is that small numbers of options for lower level employees have minimal impact on them and these employees are more easily replaced. However, my own preference is to be inclusive as I have found that recognizing lower level employees with a grant of options, no matter how small, can have meaning to them. Many others agree with the basic fairness of this.
Board members almost always receive options because often this is their only meaningful compensation. Same with advisory board members. Advisory board members usually receive some discounted portion compared to a board member, acknowledging the difference between board and advisory work.
Even within the board there are often differences in numbers. The Chair may be granted more options than regular board members. And when governance goes into high gear, there can be additional allocations granted for chairing individual committees.
The numbers game: a rough guide to stock option allocation
- 75% – 85% for the employees and consultants
- 5% – 10% for the board and advisory board
- remaining 10% – 15% of the pool for contingencies
Being inclusive is great, but options for company counsel, accountants, landlords and your pets may be going too far. Especially if you are otherwise paying full tariff for their services.
(My dog keeps me company in my home office but I don’t find that he contributes to my business in any meaningful way. These biscuits are simply not for him, paws off!)
Next up, the tricky art of option terms for employees.
David practiced corporate finance law for 20 years representing numerous technology companies before retiring to co-found a venture capital fund where he was a partner and portfolio manager for ten years. He now provides corporate finance/M&A advice to a portfolio of tech companies with a view to growing them to the point they are ready to exit and then leading that process.
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