Startups are not easy. Why? Because it costs money (no matter what) and especially if you need others to make a business happen (i.e employees)).When you cannot afford to pay employees or investors a lot of money, stock Incentives are a popular way to compensate employees in a startup (which is a Share in the company’s equity). This gives the workers an option to buy the stocks without any external tax. But these stock incentive plans are often only offered to the senior management and/or the top-tier employees.
Here are three important things you should know about Stock Incentive plans:
- They are regularized and fixed plans that a startup provides its employees for the purchase of a portion of the company’s shares.
- They come with certain restrictions and policies that are already fixed by the company. These plans help the company to attract talented and incentivize employees that are looking for a long-term partnership with your company.
- Normally, a startup company reserves 10-20% of its equity shares for stock incentive plans.
Safe or Risky:
Buying a stock incentive plan can be both safe or risky. This depends on several factors. Although, there are always chances for a startup program to fail badly, these chances can be reduced by thoroughly analyzing the company’s structure, vision, and short and long-term objectives, before investing. The goal of any stock option is to weigh risk and mitigate what you can but also understanding if you accept there are no guarantees.
How to Make a Stock Incentive Plan?
If you’re a startup founder, you’d know how hectic it is to build a company from the ground up and map out doing day-to-day functions (especially trying to consider all avenues that would help increase revenue in the out-years. This is why we have outlined the key steps to making a stock incentive plan for your startup company:
1) Setting the Foundations:
The first step to making a stock incentive plan is to set its foundations. That is, to:
- Track all the investments
- Estimate the value
- Develop an equity philosophy
- Sketch out a plan
- Discuss it with the co-founders
- Make it official through the legal procedures.
Each of these steps will present hurdles along the way. Before designing an idea for the plan, you must estimate all the values of the shares involved and the impact it will have on your company. Once you’re done with getting approvals from the board and the co-founders (if any), the next step will be to get a legalized permit. This process will require a legal service that understands all the needs of a startup business. This is crucial so ensure you do your research before settling on a company.
2) Tracking the Target Pool
The stock incentive plan purely depends on the number of stocks you’re willing to share with your stakeholders and/or employees. This is why you should first take notice of the size of your company. From the managerial positions to an entry-level employee, you will have to divide all the workers in specific pools.
This is because you will be offering different plans for different pools of employees. For instance, a senior manager in the company can buy 1-5% of the stocks. But an entry-level employee could be restricted to only 0,5%. This creates a sense of value between different types of employees and restricts the overall stock incentives to 10-20% (the recommended range).
3) Designing the Offers
Before you go out designing the stock incentive plans for different pools of stakeholders and employees, see if the employee is loyal to you or not. Is he willing to work with you in the long-term? Is the stock size justified for his role in the company?
Another important thing to consider, while designing an offer is your budget. Before making any offer to a new hire, make sure that you have sufficient allocated shares in the company. Otherwise, you won’t be able to cover the offer in the future.
4) Finalizing the Incentive
After deciding on the budget and the offer potential, remember to write all of this down in an offer letter. This will make the offer legal and will highlight all the key points in the offer.
Before presenting the offer, it is recommended that you get the stock incentive plan reviewed by an attorney and approved by the company’s board (if there is one). The agreements made with the employee must be processed and executed on time. And all the details must be updated in the capitalization table of the company.
Designing and executing a good stock incentive plan can prove beneficial to your company. It can attract investors and employees that believe in the concept of your business; and the future of it. Any mishap in the plan can seriously hurt the chance of your startup. Unfortunately, startup founders have a lot of work on their shoulders. This is why getting legal advice for your business is the best to help you design an effective stock incentive plan.