Q:  When setting up stock option plans, what are the biggest pitfalls startups face? 

A:  That’s an excellent, and important question.  Stock option plans are by far the most expensive benefit that startups can offer their team members, so the most important objective is to make sure they are actually perceived as truly valuable.  Two perceptions potentially fatal to that objective are:

          1.   Grant amounts are unfair or inconsistent: A real morale-killer is the perception that how you parcel out the stock is arbitrary, or based on how effectively an employee negotiates rather than on how much value he or she adds.  Some actions that will help here:  

• Have a plan – a basic philosophy and approach to your strategy to attract people to the   company and retain them.  You should have a sense of how you want to distribute shares by (a) employee level, (b) functional area, and (c) new hire vs. follow-on grants.  

For an excellent piece on a coherent, planned approach to granting equity, see Andy Rachleff’s post at http://bit.ly/1bBZcnD.

• Write it down.  Even if it’s just a handwritten note that you keep in a desk drawer, you need something that you can refer to.  You may also need to refresh your board’s memory, when it comes time to having those grants approved.

• Collaborate.  Consider forming a small committee of key executives to review stock compensation requests.  This can contribute to the perception that there is a real process for determining how stock is distributed.  

          2.   Recipients don’t understand what they’ve gotten:   Not every key employee is financially sophisticated.  Decisions about when to exercise options, whether to hold the shares once exercised (assuming the shares can be transacted), and how to handle the tax consequences are immensely complex and personal, so it’s especially important that that your employees have a sound grasp of how to make intelligent decisions.  Some suggestions:

• Have regular communications with employees about how stock options work, preferably led by a senior executive.  (More on this in a future post) Make sure employees know how to get further, individualized help when they need it.  

You don’t want an extremely expensive, yet strategic benefit to lose its value because the recipients didn’t understand it, or felt they made bad decisions because of poor advice.

Post by Randall Bolten and Bob Berry