Sam Altman has a thoughtful post on employee stock options. Sam does a great option at covering the gist of the problem, so I won’t go deeply into that area.
It’s time for founders and boards to reform how employees participate in equity and stock programs. Here are the core problems that need to be solved:
- Companies are not transparent enough about how common stock, and stock options, will be worth in the event of a liquidation event. Stock preferences, participating preferences, debt and more make it very difficult for employees to understand if, and when, they will receive any value from their stock options. While fiduciary duty must be respected, startups should provide basic guides to employees at time of grant. For example: “Based on your exercise price, the company will need to sell for at least $20 million for you to receive any positive value.” Not a lot of intimate details, but at least an employees knows where they stand.
- The time to exercise stock options for employees should be changed from 90 days to 10 years. But, the initial cliff for vesting options should be extended from 1 year to 2 years. Here’s why: let’s say one of your first 10 employees does an incredible job helping your company grow. She spends 60 hours a week for three years doing whatever it takes to get the company to the next level. After three years, she decided she needs a change and decides to leave the company. Under a typical scenario, she will have to A) exercise her stock options within 90 days, typically paying tens of thousands of dollars to get her stock, and B) she will be immediately taxed the value of the difference between the current stock price and exercise price, even though the stock is illiquid and may never become worth more than monopoly money. For most people, this is an unattractive scenario. Every BoD knows this.
- The right thing to do is to reward employees with multiple years of service with extended options timeframes, letting them enjoy the fruit of a liquidation event, even if its years later. And to do it without putting their personal savings and family at risk.
- By extending the initial cliff from 1 year to 2 years, you only reward employees that make a substantial contribution.