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Question: I've got a great idea for an internet software company but don't have the money to pay a developer, and I've been told I need a prototype before I can raise venture capital. Assuming I can convince a developer to work for stock instead of cash, what are the pros and cons of giving an employee a piece of the action?
Answer: Apart from letting you build your company on a shoestring, giving away stock options, warrants or restricted stock grants to key employees aligns their interests with yours and gives them an upside in the sale or IPO of your company. Depending on how the deal is structured, however, your employees may also get the right to weigh in on management decisions and share in profits--rights you may not want to give them.
According to Meryl Unger, a corporate lawyer at New York City's Katsky Korins LLP, it's better to issue stock options (the right to buy a fixed number of shares during a specified period at a specified price) than to give your employees outright stock grants. That's because stock options allow you to give up less equity and retain a greater degree of control, because employees don't actually acquire the shares (or any management rights that come with them) until the options have been exercised and the underlying stock is issued. Also, stock option plans typically call for a three- to four-year vesting period, so employees need to stick around for a substantial period of time before capturing the shares' full value. However, stock options also come with legal and tax consequences, both for the company and its employees. It's important to have an attorney draft your stock option plan and to consult with your accountant to make sure the options are priced at fair market value.
Rosalind Resnick is the founder and CEO of Axxess Business Consulting, a New York City consulting firm that advises startups and small businesses.