For decades, stock option plans have been a common part of an executive’s compensation package. During the dotcom boom of the late nineties, stock options were a major draw that brought top talent to emerging tech companies. By offering a part of the company’s future growth and a percentage of the wealth the company would generate, start-ups were able to offer lower compensation packages and hold on to their cash. However, after the dotcom bust, many of these companies became insolvent, and executives were left holding worthless stock options.
Today, stock options are still a part of the packages offered by many companies. However, they typically serve as an added perk and not as a replacement for a competitive salary. In addition, employee stock options are no longer reserved for executives, and now exist for many other employee groups at businesses of varying sizes.
What exactly are employee stock options?
A stock option is an offer by a company that gives employees the right to purchase a specified number of shares in the company at an agreed upon price (usually lower than market value) by a specific date. The employee is under no obligation to purchase all or part of the number of shares noted in the option. The choice is theirs and they can normally purchase stock at any point during the time period between the offer and last exercise date.
Certain types of stock options also provide employees with the ability to convert part or all of the potential compensation package into capital gains for tax purposes.
What are the pros of offering employee stock options?
What are the cons of offering employee stock options?
- They offer employees an opportunity to have ownership in the company they work for and feel more “connected” to the business as well as to their co-workers.
- They are a cost-effective company benefit that can help make employment packages more attractive.
- From a human resources perspective, they may increase staff retention, as the vesting of stock option stipulates that require employees to remain employed for a certain period of time before the shares can be issued and sold.
- Employees can reap some of the financial rewards of a successful business, which increases dedication for all employees involved, as they are more invested in the company and its results.
- They can serve as a sound investment for someone with a long-term financial strategy. Company stock options allow employees to invest without paying broker's fees.
- They can offer some tax benefits.
When do stock options work best?
- Although stock option plans offer many advantages, the tax implications for employees can be complicated.
- Dilution can be very costly to shareholder over the long run.
- Stock options are difficult to value.
- Stock options can result in high levels of compensation of executives for mediocre business results.
- An individual employee must rely on the collective output their co-workers and management in order to receive a bonus.
Stock options are most appropriate for small companies where future growth is expected, or for publicly owned companies who want to offer some degree of company ownership to employees. As previously stated, stock options should generally be used as an added incentive, and not as a substitute for a fair salary.