Exercise Your Options

Benefiting From Options

Just what can stock options do for you? Plenty--in recruiting, employee retention and employee motivation. But first, you need to understand the basics; namely, options are not stocks but rather the right to purchase stocks at a specified price, usually at a date well into the future.

Why not just give stocks to employees? Stocks have a superficial simplicity in their favor, but look deeper, and the arguments are all in favor of options. For starters, options have minimal tax and accounting impacts, at least until the options are exercised. Tax implications of stock grants are far bigger, and the impact is immediate.

"There are so many ways awards of stocks can go wrong for you and your business," says Wilton Sogg, an attorney with Hahn Loeser & Parks in Cleveland.

Sogg points out there are many "what-ifs" to consider before awarding stocks: What if the employee quits? Gets fired? Becomes disabled? In any of these cases, you'd want a legally valid buy-back agreement prepared well in advance (ideally in tandem with handing over the stock certificates). But buy-backs can still go awry. What if you lack the cash when you need it? What if the employee's lawyer finds a loophole in your buy-back agreement? A disgruntled minority shareholder is always bad news; give out equity, and you may be preparing the way to give yourself exactly that. Says Sogg, "There are many better, smarter ways to give employees incentives."

At the head of that list of smarter ways is options. First off, options can come with many attached strings, a common one being that they can't be redeemed until a specific date. "Four years is a common vesting period," says Marlee Myers, an attorney and managing partner in the Pittsburgh office of law firm Morgan, Lewis & Bockius LLP. But a vesting period of anywhere from three to six years is normal, she adds.

Attaching a multiyear vesting period to options helps retain employees, says David Morse, a partner in the law firm of Whitman, Breed, Abbott & Morgan in New York City. "If the employee leaves before the options vest, they lose the options," Morse says. "They have to stick around to get the pay-out. That's a big plus because hiring and training new employees is so expensive."

Hiring better people is another key benefit for companies that use options wisely. "By offering equity, [companies] give employees a chance to make big profits later," says Myers. Many job candidates will jump at this deal. And that means a lean, cash-strapped business can often hire employees at lower pay. Not all job candidates will find this prospect appealing--but the high-energy self-starters you most covet likely will.

Once employees are on board, options can jump-start their commitment. A few stock grants won't mean an employee will suddenly share your appetite for 80-hour work weeks--but options will likely prompt the employee to invest discretionary energy and creativity into his or her job. "Options can definitely make employees more motivated," agrees Morse.

That said, don't take your employees' enthusiasm for options for granted. "You have to market the value of this program to them," says Morse. You need to spell out to employees that every stock option makes them a partial owner.

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This article was originally published in the April 1998 print edition of Entrepreneur with the headline: Exercise Your Options.

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