Stock options plan for startups
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Whether or no those shares will hold voting rights or not depends on the individual case. The overall goal of implementing an ESOP plan is to create a tool for the management to attract, retain and reward key staff members economically. In the most cases I have seen there are no voting or other rights attached to those shares.
The idea of stock options works specifically well with companies listed at a stock exchange. Exercising an option to buy the stock at a certain hopefully lower than market price results in an immediate gain and you can sell the stock at a higher price the same moment. This prevents a massive cash outlay in the first step and also provides liquidity for covering income tax payments resulting from the capital gain. With private companies espec. GmbH it would definitely cause a lot of administrative hustle, since those contracts have to go through the notary and have a lot of implications on taxation issues.
With shares not being publicly traded most employees would have difficulties to come up with the needed liquidity to first buy the shares, cover resulting income tax and then waiting for a chance to sell the stock later on. A VSOP, also known as phantom stocks, is not really an option plan.
Instead, it is a monetary compensation based on the value of the stock. It simulates an ESOP program thereby preventing all the problematic administrative and tax challenges. It is an arrangement that obligates the employer to pay the employee an equivalent price to the value of phantom stock accumulated by the employee at a given time usually after a defined event, e.
DIY Employee Stock Option Plan (ESOP) -
Employees get rewarded with phantom stocks underlying the same terms as ESOP shares would have e. Vesting, Exercise price etc. These stocks are only virtual and cannot be converted into company shares, but its equivalent value in cash. At the time the options are exercised e. For technical reasons it is important to keep in mind that this is a liability of the company towards its employees. The primary benefit of ESOPs to employees is the difference between their exercise price and the fair market value after their vesting period is concluded.
A good practice with exercise price is to keep it as low as possible relative to the current value of the total equity. The lower it is, the greater the profit margin for the employee when he exercises his option. Strike Prices can vary quite a bit in startups. I have seen anything from nominal value e. Granting options with a strike price of 1 EUR to early employees might be fair while from an investors perspective it is also fair to set the exercise price to the share price from the latest financing round for employees joining the company around that time or after the round.
The overall idea here would be to let employees share in the gains they helped to create.
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Its important to understand that options are a margin business. That means holder of options benefit from the difference between current share price and their strike price. These programs normally rank behind all liquidation preferences. The vesting schedule is the outline of the duration with which an employee garners his or her stock options until he can exercise his or her options.
It begins when the ESOP contract has been drawn. The custom is to spread accumulation of the agreed stock options amount over four years sometimes three years, other times for longer duration. There is usually a cliff period , typically a year part of the vesting schedule where the employee does not accrue any option at all. The employee gets the total shares he is entitled to over that year, all at once after the cliff period. A good chunk of the programs I have seen contain accelerated vesting clauses in case of exit event.
Through such clauses all options become vested in the moment an exit event occurs. Good for the holder of the option not necessarily though for the buyer of the company. In this case the holder of the option can cash out his entire vested options and leave the company with hopefully a pile of cash. However, this might lead to a significant brain drain for the company. Hence, it should be in the interest of shareholders to retain key employees and make sure that those milestones are met. Every program needs to consider what happens when employees leave the company within the vesting period and after the vesting has lapsed.
You have to make sure that employees leaving the company return a part of their options to re-allocate them to new team members or the remaining staff. Good leavers normally keep their vested options and return the unvested portion. They leave the company for a good reason, such as changing jobs for career advancement or moving abroad with their families. Some programs also contain a call option on the vested shares for the company.
The call option would allow the company to buy back the vested options in case the employee decides to leave. As long as the company has sufficient cash to do so this allows to manage the ESOP pool and distribute the options that have been bought back to new employees. Bad leavers are normally fired from the company because of serious misconduct such as fraud or setting up a competing businesses.
Vesting makes a big difference.
Average rating 4. Vote count: No votes so far! Be the first to rate this post. Follow him on Twitter Timberry. Ownership Shares and Your Business Plan. Read Funding By: Tim Berry. The classic stock option is an option to buy a share of stock at a specified price. Say you get to buy some number of shares for a penny each. If those shares are worth meaning they can be sold legally for more than that penny, you make money.
In theory. Understand the basic numbers on shares in a company: charters specify how many shares there are, and if you know that number then you can guess what a share is really worth by dividing what the company might be worth by the number of shares outstanding.
Employee Stock Option Program (ESOP)
None of this matters until a company is actually traded. Call that a liquidity event, and investors call that the exit.
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Meaning that it was pretty hard to sell them; usually impossible. Shares can also be worth money when a big company buys a startup.