A brief history of employee stock plans: why companies need them
Initially, stock plans were designed by large companies in the late 20th century to find a way to tie executive compensation to the performance of the company and to further incentivize them: earnings from the sale of stock at some point would bring financial gains and tie executive performance to pay.
Later on, around the time of the .com bubble, the idea was to bring more of that “entrepreneurial spirit” or “sense of ownership” to a broader set of team members. So we started to see companies, especially tech and early-stage companies, leveraging stock plans. Today, stock plans allow differentiating between forward-thinking companies and those who stick with the 20th century’s labor and social contract. While more and more SMBs and private companies are using stock plans they are still much more popular in the US than in the EU, and there are reasons for that: the US do not necessarily have a workers council, or representation of workers on the company board, whereas countries like Germany and Northern European countries have a mandatory representation of workers in the board. So in Europe, that sense of “ownership” is traditionally considered to be present via these mechanisms of the presence of the workers on the company's board.
Using stock plans for employee incentivization: what they can and cannot do for you
Throughout my career, whether as an engineer or as an executive, all of the companies which I worked for had some form of a stock plan for employees. Stock plans allow a company to educate its employees about the mechanisms for the growth of the company, the finances of the company. They create additional interest in the company’s well-being.
What you can achieve with stock plans
Broader interest in the company’s functioning mechanisms and growth;
Higher retention, for the duration of the vesting period; Even loyalty;
A slightly stronger sense of community around your company’s values and objectives;
A way to align compensation to your values and culture: what do you stand for? Performance? Inclusion? Loyalty? Customer obsession? All of the above?
What you cannot achieve with stock plans
Significantly higher productivity or performance;
True entrepreneurial spirit;
To this date, from all studies that I've read and from everything that I've experienced myself, there is no real relation of causality between awarding stock and having higher productivity or performance. A true entrepreneurial spirit or a profound sense of ownership, unfortunately, is not something you will achieve to the full extent that you envision with stock plans.
How to create a stock plan
First of all, you need to define a “shares budget” in agreement with your board, upon the latest investment round. Depending on the stage of the company, it can be between 5% and 20% of your total shares. Split it between new hire grants and award grants, based on headcount projections and KPIs of the company. Decide whether it will be stock options, RSUs (Restricted Stock Units), or a ghost equity plan – based on the geography of your hires versus the country of incorporation. Establish a yearly budget based on these projections.
Monitor a yearly “spend” of this budget: How much was allocated grossly? How much has come back into the pool (as a result of employee turnover) and what is the net spend?
A stock plan must be aligned to your culture and mission and must be part of a broader compensation & benefits strategy. It cannot stand by itself. (It’s useless to talk about it if your employees are not getting paid on time, for example). It takes a strong partnership between HR, Legal, Finance (Tax), and the leadership team to deploy. Communication is key, but readiness is the cornerstone. Too early communication can hurt you if you are not ready. You should partner with experts for the pre-IPO stages (Payscale, Radford, Mercer – Comptrix) and establish a Compensation Committee 1-2 years pre-IPO.
Elements of a stock plan
Depending on the stage of the company, it is important to decide whether you will award stock options, restricted stock units, or a ghost Equity Plan. This decision is essentially based on the geography of your hires versus the country where you're incorporated and where you are issuing the stock from.
Very common in countries where there is an incentive for this mechanism – where income from them is taxed as capital gains and not salary benefits: the US, Belgium, some of Eastern Europe, India. They have a Strike Price! Define time-to-expire of the options.
RSUs (Restricted Stock Units):
To be used in countries where stock is considered a salary benefit: France, Germany, Northern Europe countries, most ASEAN countries. Also, can be used when the strike price of the option becomes high if your objective is to disseminate the “owner mindset”. Consider double-trigger for vesting, because most countries tax this as income upon vesting. Define time-to-expire for RSUs.
Ghost equity plan:
To be used in countries where there are trade limitations or limitations on how you can work with those employees. Examples: Russia, China, UAE – for a US-based company. Do not forget to provision for it, tax-wise!
Time-based stock plans
You can use stock plans for retention purposes and base them on time and/or certain events.
Establish the kind of retention you are trying to achieve: 3 years? 4 years? 5 years?
Keep in mind that executives – VP and above – in fast-growing companies have an average tenure of 2 years
Establish the cliff: how long before you can decide whether or not a person should stay with the company? 6 months and 1 year are the most common.
Establish a vesting mechanism: time-based only? Time and event-based (double trigger)? Keep in mind tax implications for this decision;
Define exceptions: for executives and/or key hires – especially around accelerated vesting;
Performance (KPI) based stock plans
You can have plans that are uniquely based on performance, either of the individual or of the company. There are some questions you’ll need to ask yourself about using performance-based stock plans
Upfront or with a vesting mechanism?
Discretionary (based on leader decision) or based on performance reviews? Do you have performance management in place?
Across the entire company (“butter spread”), based upon achievement of some KPI?
Available to everyone or just key departments?
How much to allocate
One way to allocate stock is by using a multiplier for yearly gross salary. In my experience, I've seen unique multipliers by departments with the differentiation between executives, key hires, and the rest of the workforce. You can come up with an allocation grid or use a simpler plan. We usually see high multipliers in product and engineering, also in sales, and lower ones in customer success or other support functions. But it depends on the individual company and its business strategy: which departments/key hires (your “golden nuggets”) do you want to incentivize the most?
Timing the stock plan
The date when you get the document out and signed.
Start vesting date:
The date when the stock starts vesting. Most commonly, the hire date.
The period during which you can change your mind about the hire (or them about the company) and no stock has been vested.
How much shall vest regularly after the cliff & WHAT is vesting. This has tax implications: some countries require you to pay taxes upon vesting (not monetizing) of the stock.
How much time after termination / an event can the beneficiary exercise their options.
4-year monthly vesting with a 1-year cliff, means ¼ of the stock will vest at the 1st anniversary (based on the Start Vesting Date) and 1/48 of the stock will vest every month after the 1-year cliff.
Common pitfalls you should consider when introducing a stock plan
The most common and most painful pitfall is the lengthy process between the moment of promising the plan and getting the plan. Don't promise it if you cannot really do it in the next 3-4 months, because it creates a lot of frustration. If your process is too lengthy, it's better not to do it. Tell your employees honestly that you’re planning to do it later on and that they will have a start vesting date that's equal to their hire date. Just be realistic.
Other pitfalls include:
The difference between the Start Vesting Date and the Grant Date leads to a different Strike Price, in the case of stock options.
Lack of tax provisioning or lack of understanding of tax implications.
No window/opportunity to monetize for a long time.
100% discretionary by the CEO, with no framework.
How to communicate your stock plan
When talking about the value, there is the question: how do I talk about the value of the future stock, especially in an early-stage company?
Always value-based and never %-based, or on a number of units & strike price.
When talking about the value, talk about the current value, but give an outlook with 2 coordinates:
– Conservative estimate (at the end of vesting);
– Optimistic estimate;
In the case of executives, a good question is: “How much money do you want to make in the next X years?” and establish a package based on that.
DO NOT communicate that you are doing it until you are ready to do it.
Stock reward in itself is a promise of future value. And it takes a leap of faith.
What I always told future hires is this:
“If you want to take this leap of faith together with us, we're all in this. Do you want to take this leap of faith with us? If you're too risk-averse to jump into a company that awards and pays people also based on stock options, then don't do it.”
It was typically a bad sign for me as Chief People Officer when a future hire, whether a leader or not, would demand a higher salary piece and say that the stock was just the future promise that they did not care about. This was typically a no-go for me.
Gaining a competitive advantage by introducing stock plans
In Europe, we're still far from stock plans becoming mainstream, as founders often shy away from implementing them – mostly due to varying tax regulations between jurisdictions. However, if done right by considering all of the above, introducing a stock plan for your employees can present a powerful competitive advantage for your company!
About Marius Istrate
Growth Strategist, ex-Chief People Officer at UiPath
Marius Istrate is a hybrid work advocate and ex-Chief People Officer for UiPath, where he grew the company from 120 to 3000 people in 3 years.
Marius is a Venture Partner at 3VC, supporting our portfolio founders to build great teams, to set them to perform, and to scale the company culture. As tech companies increasingly shift towards remote work, he also guides them through the transformation process to reap the benefits while managing the potential pitfalls.