Should I Offer a Stock Option Pool?
An ever-more common option for dividing equity for startups is a stock option pool. Equity compensation is a fairly common incentive that business owners use to pull in talent within their industry and encourage employees to work hard in order to make the company more profitable. Stock option pools are just one among several ways to offer equity to employees. A pool enables a business to reserve a specific amount of company stock for stock options to be granted to employees. Although many organizations find this structure to be convenient, it is not always the best choice and alternatives may better suit some companies.
Stock Option vs Restricted Stock
Employee equity compensation can be offered in the form of stock options or restricted stock. Before deciding how to pay equity distribution, companies must consider the limitations that come with each type of compensation. With restricted shares, the employee takes on a more traditional stockholder-like role and has dividends and voting rights. In order to keep control of the business, employers may also reserve the right to repurchase restricted shares or maintain the right of first refusal. Stock options have more limitations. Typically, employees only have the ability to purchase company stock in the future at a predetermined price. This does not grant the employee dividends or voting rights, but it may result in a windfall if the price of the business stock rises above the predetermined level. Employers ordinarily do not retain the right to repurchase stock options because there are no voting rights and no predetermined number of shares. In order to promote long-term employment, vesting restrictions might be applied to both restricted stock and stock options.
How Does This Impact Employers?
Employers who make use of stock option pools may lack control over how many employees will exercise their stock options and how much this will reduce the value of the shares of the founding members. Additionally, the corporation is unable to “claw back” shares through buyback rights in order to preserve this value. Before establishing an employee stock option pool, it is necessary for companies to be aware of these risks.