Startups need ways to incentivize new employees, especially when they do not have the cash to provide high wages at the outset. Equity is key to enticing new employees and to competing with larger, established companies. Introducing a stock option plan can offer compensation to employees in lieu of higher wages.
What is a Stock Incentive Plan?
You want great employees but don’t have the capital to spare (or need to conserve it…for now). Startups can offer equity to attract quality employees, and employees may engage with startups knowing stock options are available. The stock incentive plan rolls out options to purchase shares once an employee provides services. Stock options provide the ability to purchase stock at a certain price. If the company grows and finds success, the shares will increase in value, which employees will find a win.
Benefits of Stock Incentive Plans
The ability to attract employees without being able to give high wages with stock incentive plans is a clear benefit of the plans, but there are other benefits to consider:
- Incentive and retention. Employees who hold stakes in a company will be incentivized to be productive in working toward the company’s success. When employees are incentivized to contribute to their company’s success, they stick around.
- Conservation of cash. Stock incentive plans allow companies to preserve capital in their early stages as they grow. This conserved capital can lead to hiring new talent as well.
- Cheap valuation at startup: When a company starts out, their stock valuation will be very low. Low-priced stock options may be attractive to new employees and may incentivize top talent.
- Vesting. You can further incentivize employees by offering time-based vesting: the longer they provide services, the more shares they will be able to buy.
How Option Plans Function
Stock options are offered on a grant date and employees can later exercise their right to buy options on the exercise date. The employee may then sell the stock or hold on to the stock for a period of time.
A company’s board of directors must plan and approve the plans. Companies can offer stock in different ways, so it’s important for them to understand the legal and tax implications.
How Shares Are Priced in a Stock Incentive Plan
A company’s board of directors will set the fair market value for their stock at startup. Since they are new, a company’s market value may be low. A lawyer familiar with plan structures and legal implications of these plans may be consulted to ensure everything with the plans run smoothly.
Founders may adapt their plans to future hires and funding rounds. Founders, then, need to realize there is ongoing work involved in making use of stock incentive plans. Refreshing stock option pools is crucial so that founders can be sure that they have the options available to hire new employees.
It’s critical, too, that founders measure current hiring against their hiring plan so that they understand who they need to hire, yet.
Stock Incentive Plans Are Complex, Yet Beneficial
Tax rules for these plans are complex and require ongoing work, but they can benefit new startups and employees. This is a general overview, so startups interested in such stock incentive plans should consult experts and dive more deeply into the issue. They can help businesses conserve capital while recruiting talented employees, so they’re worth considering – especially early on in your companies life when money right now matters more than money in the future.