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What you should know before offering stock options to employees

Bhupendra Sharma
2nd Aug 2016
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The startup culture is booming, and so is the trend of offering stock options (ESOPs) to early-stage employees. Some say it gives a sense of ownership to the employees, while others connect it to the talent that they bring to the table. However, the truth goes well beyond these two notions. Startups offer a piece of their company to new employees hoping that it would work as a confidence booster and motivate them to take the company to greater heights as they also would have a stake in the company. Plus, it makes the retention process as easy as it can be.

employee stock options

If you are a startup founder who is planning to offer ESOPs to your employees in the near future, here are a few important things that you should know:

Different types of equities

By providing a small percentage of your firm's equity to employees, you give them certain rights. So, make sure you know that equities are of two types: common stocks and preferred stocks. The preferred stockholders, as the name suggests, are preferred over common stock holders and always get paid first. This is the reason startups around the world offer common stocks to their employees and preferred stocks to investors.

Stock option versus restricted stock units

There are two ways in which startups can offer equity to their employees: as stock options or as restricted stock units (RSUs). Under a stock option plan, employees are allowed to buy a pre-specified number of stock units at a nominal price (strike price) regardless of the change in the value of the company's stock price in the future. On the other hand, under the RSU option, they are awarded stock units right away with no possibility of buying them in the future.

Taxation comes in handy

The equity option isn't always free for employees. Sometimes, it may expose them to excessive taxation. It all depends on whether they're granted stock option or RSUs. Before taking any step, it's always recommended to understand the tax treatment of ESOPs and take a decision accordingly to ensure that your employees don't turn down the offer.

Granting, vesting and exercising

You should strengthen your knowledge about terms like granting, vesting and exercising as soon as possible. Granting is the process of issuing stocks to employees and vesting refers to an employee's right to apply for those stocks. Exercising of ESOPs is when the employee converts and owns the stocks granted to them. Learn the basics of ESOPs before moving ahead.

ESOPs give startups the liberty to hire the best talent from the market without emptying their pockets fully. They create a win-win situation for both the parties as companies can hire skilled employees with long-term commitment while the employees can have a sense of ownership in the organisation, which further reflect in their performance.

So, use ESOPs wisely to add value to your startup. Keep the points mentioned here in mind to avoid unnecessary confusion at the time of allotment.

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