When a startup is in its early stages it needs to attract talent to nurture a team that allows it to start with strength. However, it is also in these early stages that it is not yet able to offer competitive salaries like those of other large established companies. To solve this situation and to encourage present and future employees, some companies use stock options.
The term refers to a supplement to the financial remuneration of workers, managers or employees of a company. This mechanism, very popular in the United States, gives them the right to buy shares of the company at a fixed price that coincides with their fair market value (stock options) at the time of issue. They may exercise it for a specified period of time after which the options expire.
How do stock options work?
Thus, the beneficiaries will receive the stock options according to a long-term compensation plan established by the company. Their terms, which are set out in the shareholders’ agreement, stipulate how they will be able to exercise their call options: either suddenly at the end of the period or gradually over that period.
Stock options as an incentive
Stock options help to retain talent, as the conditions of these rights oblige employees to be part of the firm’s team for a certain period of time in order to acquire some or all of the shares to which they are entitled. But one of the main objectives of offering stock options is to involve employees and managers in the evolution of the startup. At the end of the day, workers are contributing their efforts to the growth of the company.
If they have the possibility of buying shares in the company, they will have even more reason to fight for the best results, as they will be able to benefit from the increase in the value of the company. In this way, the mechanism can act as a cost-effective employee compensation plan that replaces other economic formulas.
Thus, the benefits they will obtain once the term of the stock options has expired will depend on the evolution of the startup. If the exercise price of the option is then lower than the actual or potential market value of the shares, the employee or manager may make the purchase and then sell his or her shares and make a profit. However, if the shares are below the so-called exercise price, it would not be in the employee’s interest to exercise the right to purchase.
This mechanism, widely used by US listed companies in the 1990s to reward their managers, has become very popular in the Silicon Valley startup ecosystem. Thousands of workers and executives from companies such as Facebook, Twitter and Google have become millionaires thanks to this type of plan. In fact, many of the top managers of these companies give up their salaries to support themselves only with this type of compensation.