Does a startup need to issue options to employees in 2021? We analyze what it is and how to arrange

In the 21st century, where no programmer can be surprised by a tennis table, PS5 and a drawer of snacks in the office, you need to think about new ways to motivate. No startup can afford to compete with the salaries of talented employees, including programmers, tech giants. To interest an employee in his project, so that he, like the owner, worries about the development of the company, you need to share. Share time. Share good rewards for the work done. And share stocks or, more correctly, “stock options”. For the time and money, everything is clear. Let’s figure it out with options.

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The option enables the employee to receive an offer to buy a portion of the company through options on common stock at a low price. If the company is successful, the employee can sell the stock at a higher price.

Simply put, options, or as it is commonly called “Option Programs”, are employee benefits. They are used as a personnel motivation tool, are popular in world practice, especially in the USA, but every year in the CIS countries they want to know more and more about this tool.

How options work in the USA

In the United States, option programs do not lose their popularity, because in addition to motivating employees, there are several more advantages. First, the allocation of an option pool is often a requirement of investors. Thus, American investors can be sure that all talented employees of the company are looking in the same direction, are interested in staying and developing the company.

Secondly, there is a favorable taxation regime in relation to shares repurchased under options.

Execution of a stock option agreement in a US company

The Stock Option Agreement consists of four main documents:

Stock Option Plan (stock options plan). The main document of a company on the issue of stock options. Contains the conditions for granting options, including the purchase price and any restrictions.

Individual Stock Option Agreement (individual share option agreement). Individual contract between the company and the option. The number of options to which the employee is entitled, the types of options granted, the schedule for the transfer of rights and other terms of issue for a particular employee are indicated.

Exercise Agreement (performance agreement). The conditions under which employees can use the options are described in detail.

Notice of Stock Option Grant (notification of granting a share option). May not be included in general documents, a notice of the grant of a share option is usually also included in a share option agreement.

The vesting of rights to shares is called vesting. The employee does not immediately receive all the shares; their purchase is stretched out in time in accordance with the vesting schedule. The longer the option holder works, the more shares he can apply for.

The standard vesting schedule is 4 years. In the first year, there is no issue of shares – cliff. Upon completion of the cliff, the right to 25% of the pool of all shares of the option is granted. Further, the remaining 75% are distributed in equal shares and issued once a quarter. But such a schedule is not required, each company can create its own vesting schedule.

The main disadvantage of stock options for a company is the potential dilution of other shareholders’ capital when employees use stock options.
Investors know this and often ask startups to set up a fairly large pool of options before investing. If done before investing it will not dilute investors.

The table shows the difference between a $ 1 million investment valued up to $ 3 million and no option pool and the same investment with a 15% option pool set prior to investment.

A very popular question, how options differ from premiums.

For employees, the main disadvantage of options in a private company compared to cash premiums is the lack of liquidity. Until the company creates an open market for its shares or is acquired, the options will not be the equivalent of cash payments. And if the company doesn’t get bigger and its shares don’t get more valuable, options may ultimately be worthless. This is one of the main differences between premiums and options. Where there are more advantages, you can draw a conclusion yourself.

Large corporations Google, Microsoft, Skype and others, which can afford both big salaries and huge bonuses and the best incentives for talented and key employees, provide options, but each company does it beautifully in its own way.

Microsoft had an employee options program. In 2017, the decision was made to introduce a new program for employees, Restricted Stock Units. This was most likely due to frustration among workers, whose options do not have much value because the underlying stock has never appreciated. Employees are provided with real shares, not just the opportunity to purchase them. The catch is that the shares cannot be sold (hence the name “limited shares”), and the company has the right to buy back the shares if the employee has not achieved certain results at work or leaves the company within a certain period of time. For example, a company has the right to buy back 100% of an employee’s shares if the employee does not stay in the company for one year, 80% if the employee does not stay in the company for two years, and so on. Over time, the company will no longer be able to redeem shares from an employee.

How options work in Russia

The option program of the well-known Tinkoff Bank involves both top managers, programmers, developers, analysts, lawyers, PR specialists and marketers. According to the latest data, more than $ 176 million of shares are under their management. More than 5% of all shares have been reserved in the Tinkoff group to reward employees. The corporatization program at Tinkoff is designed in such a way that the employee receives shares in blocks over several years, and the amount of dividends depends on the group’s performance of annual targets. The Board of Directors approved the first interim dividend payment for the past year, totaling approximately $ 58.4 million.

Options in Russia are becoming more and more popular, so Yandex and Auchan have already shared their motivation with their employees, and Dodo Pizza has motivated top specialists from Moscow to go to Syktyvkar to develop another restaurant. But Russian legislation does not provide for provisions that clearly regulate the option form of remuneration. Therefore, the main aspects of option incentive schemes are described in labor or collective agreements or in a separate document governing the procedures and rules for the selected compensation program, for example, in the provision on bonuses. And therefore they should be well prescribed to companies and even better studied by employees.

Options for employee options

  • Founder shares part of his share with a valued employee… As a result, the latter becomes dependent on the shareholder. To fix the situation, you have to work with the documents. Additional clauses regulating the receipt of shares by the employee must be added to the agreement between the shareholder and the employee. Such an agreement will not be automatic for each employee and a separate agreement must be concluded with each employee.
  • Deferred payment. The founders of the company hardly receive 100% of the amount immediately after the sale. This allows them to maintain their interest in further business development or its integration into the ecosystem of a strategic investor.
    Applicable only in the case of an M & A transaction – when a startup is bought entirely or shares are bought from its current shareholders. Deferred payment is not suitable for motivating employees who do not have a stake in the company.
  • An agreement with an employee to provide employees with options. A start-up share option is an agreement that allows an employee, after a specified time, to acquire a share in a company at a predetermined price based on the valuation in force at the time of the agreement. Such an option is traditionally given under the condition that the employee or company achieves certain key performance indicators (KPI). Usually, at the time of acquiring a share, its real value rises significantly, and the employee becomes interested in fulfilling KPIs and increasing the market value of the startup. The company and its founders can see the real result of the employee’s activities and only then transfer a certain share to him.
  • Option program through a corporate agreement for LLC.

    When concluding a corporate agreement with such an employee, it is necessary to make him a participant in the enterprise. All possible conditions and restrictions are prescribed in the contract. You can restrict the employee’s independence in making decisions, for example, agree on a condition that the employee undertakes to adhere to a position similar to the founder, and in case of violation of such a condition, the founder can demand the buyback of the transferred share or receive some kind of forfeit. But the courts, when the rights of one of the LLC participants are infringed, stand to defend the injured party.

Stock options are becoming an increasingly common way to attract and retain employees, including programmers for companies.

Do programmers need them? Here the choice is only yours. They are not as simple as a salary, but they have the potential of a large “salary”. The terms of the option are set individually by each company. Therefore, if you go for it, you should study the agreement well: how many options the company provides and what is the term of transfer of rights, the price of the grant that you will pay when you use these options. How and when will you exercise options, and what it will depend on.

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