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5 Tips For Creating An Employee Stock Option Plan

5 Tips For Creating An Employee Stock Option Plan

Running a startup business includes planning the operations, equipment and supplies sourcing, financing, and legalities. When your startup needs employees, you may find that you don’t have enough capital to hire a single person into your business. While there are financing options, business owners may also run into requirement issues. So, instead of compensation, entrepreneurs may offer an employee stock option plan instead.

There are steps to creating an employee stock option, and it’s not to be taken lightly. The following advice can help you offer the right plan for your potential employees.

Discuss It with Your Legal Team

Creating an employee stock option requires an in-depth understanding of the process. It involves planning, management, and other fine details that you should not miss as a business owner. If you’re not careful, it can create legal problems later due to violations. Once a company starts facing financial complications that eventually affect the employee shares, you could face legal battles and lose your good reputation.

A legal team experienced with employee stock options will help you navigate the process. Take care as you will still be responsible if there are any changes to the offer made to new hires. It’s why being honest with your legal team is imperative so they can help you every step of the way.

Use Equity Management Software

Company equity requires careful facilitation, and you have many options to choose from when it comes to management software. There are features that allow you to handle capital raising with Cap Table and document storage, issue equity shares, manage vesting triggers and simplify transaction history. You’re also connected to your registered agent to update changes and avoid late fees easily.

Companies that offer equity management solutions are financial firms where related equity activities are held. If you’d rather not involve a legal team but remain in compliance with the law, you can explore another option using equity management software.

Assess the Cost of the Set-Up

While employees don’t have to pay to exercise equity early on, it’s the complete opposite for the business owner who wants to offer it to potential employees. It’s best to learn first the cost and other associated expenses related to setting up an employee stock option plan. These options can cost $80,000 to set up and $20,000 or upwards to stay running for the whole year. Make sure that the size of your business is appropriate for this kind of compensation.

Offer Stock Options the Right Way

It’s important to note that stock options in place of regular compensation can surprise and scare away the right people you want in your company. It would help to know how to explain how stock options work and the risks that come with them.

  • First, let them know that the company must have enough shares to cover the options. What the employee gets will depend on it. Understand that funding the budget of the equity shares is your responsibility.
  • It will also benefit the employees to find out more about equity shares by reading guides. Individuals can come across shares through employer offers and also by inheritance. They will need to be patient to exercise their shares later on when the company grows.
  • The size of grants that the company gives away must be assessed if it’s around 10%. There must be an independent appraisal, or a 409A, to identify the stock’s fair market value. It applies to both stocks of co-owners and employees. It’s why before settling on a stock option plan. It should be clear to all stockholders how much stocks are given away because you can’t do so without knowing how much you’re letting go.
  • Your potential hires must be legally able to work in the United States if you want to offer them stock options to your company. There might be complications later on if they have questionable status.
  • A stock option grant letter must be created as proof that a specific individual is holding stocks to your company. First, it must indicate the amount and exercise price are approved by the board that makes them valid. It also includes how many shares are granted instead of the percentage. The letter is crucial as a way of agreement between two parties.

Check with IRS Rules

Whether you’re working with a software company or a legal entity, it’s essential to understand that stock options are still liable to IRS rules. You must know how many stock options you’re only allowed to offer to your potential hires. There are also requirements that you need to know to avoid potential problems.

There are two types of stock options: statutory and non-statutory. They are taxed and reported differently from the other as well. Incentive stock options that fall under statutory options require a Form 3921 once the employee chooses to exercise the grant. It’s a requirement for tax reporting.

 In Conclusion

Creating a stock option plan for employees requires education. It would help if you had assistance from the right people or services to make sure you’re making the right choice. It’s also a difficult option for the employees to take as many would rather accept cash. But if you are knowledgeable about this type of compensation, you’ll be able to navigate your way through safely.

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by Rebecca Jones // Contributor to Businessing Magazine.

Opinions expressed by contributors are their own.