Can Employee Stock Options Make You Sick?

Too often, employee stock options and similar ownership plans are put into the wrong hands for the wrong reasons. The result: these plans may infect your business and may be undetectable until a downstream leadership or capital event.

• Two founders start a business with 50/50 ownership.
• The business thrives and grows to $45M in revenue with a key manager helping to fuel this growth.
• Seeking to reward & retain this key manager, the ownership team awards  this manager with employee stock options equal up to 4% of the company.

The clear intention was to reward this key manager. However, can you see the three ways this equity sharing structure infected the founders?

Once the manager exercises the 4% stock options, the ownership structure is now 48% each for each founder and 4% for the key manager. As a result:

• Owners have a value penalty. Each founder is suddenly a minority owner – whose ownership stake may be worth 20% less upon separation, death or disability. Ouch.
• Managers may be incented on wrong metrics. Rather than create value at speed, managers with stock ownership may become risk adverse (endowment effect).
• Governors are subject to the “Gang up” factor. The small minority 4% owner, in concert with one other owner, has now become the all-critical swing vote.

Screening tests identify problems before symptoms show up when problems are easier to treat. When designing executive compensation, carefully screen your options. Think “strategy first” across all “OMG” roles in a privately held business: Owners, Managers and Governors (Board of Directors).

At BOLD Value, we  utilize dozens of strategic value sharing screens to test and design across the spectrum of value sharing options such as:

• Equity Plans (like dozens of different restricted stock)
• Synthetic Equity Plans (like dozens of various shadow stock)
• Cash-Based Plans (like dozens of performance based deferral plans)

If you want a healthy value sharing environment, then measure three times and cut once. Avoid the OMG mistakes. Use Screens and Be Healthy.

Please contact us to learn more.