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In the world of startups, a standard and recommended option to compensate employees is to grant stock options. However, founders and employees in LatAm have not quite embraced this yet.
A stock option plan (SOP or SO) refers to the option that employees have to buy some shares of the company where they work, as long as certain conditions are met.
An SOP is a way to share the success of the company with its employees, but it’s also an incentive. By becoming stock option owners, workers stop being simply employees and become potential shareholders of the company. This means they could become much more involved in the success of the company and its consequential rise in shares.
Stock options can also be important for young startups that still can’t compensate their employees as handsomely as they would like.
Shares included in an SOP can also refer to the quotas of a company. Stocks of a private company, opposite to those of public ones, are more illiquid by nature. Their speed and frequency of buying and selling are lower.
Still, betting on the accelerated growth of the startup where you work is risky, but it can be promising – as was the case with the employees of European scaleup Klarna.
How Do Stock Options Work?
The good thing about buying shares through this plan is that the SO contract sets the price that the employee must pay per share. In other words: if the company is doing well and the employee meets the conditions, he or she buys the shares at a discounted, previously agreed upon price. If things go badly, they don’t exercise the option and don’t have to buy anything. In the end, the employee is the one who decides if they want to exercise their right to buy.
SOPs may vary by company, but they all follow the same format. Some familiar concepts are:
- Stock Option Grant: is the total amount of shares (or stocks) that one will have the option to buy if they meet the conditions. The Option Grant is calculated based on the employee’s salary, role, or position.
- Cliff: is the initial period that an employee must stay in the company to be entitled to their initial shares. Generally, this period is one year. Only a portion of the shares can be exchanged once this minimum period is met, and the rest are accumulated little by little according to the concept below (vesting).
- Vesting: the SO time scheme in which a person will have the right to buy, depending on the amount of time they stay in the company. Commonly, 100% of the shares can be collected in 4 years time, during which the remuneration to employees for all their effort is already significant.
- Linear: the most used in the US, where each year that passes one accumulates a ¼ of their shares. If you have to wait 4 years, there will be a 25% accumulation at the end of each year.
- Progressive: most used in Europe. At the end of year 1, the vesting is 10%. 20 % is added at the end of year 2, 30% at the end of year 3 and 40% in year 4. The total sum gives us 100%.
- Strike Price or Exercise Price: is the value that each employee will pay for each of their actions if they decide to do so. This price is defined in the SO contract and is equivalent to the share price on the day that the SOP contract is signed (that is, it considers the company’s valuation).
An Example in Stock Options: Fintual
This general fund administrator based in Chile decided to give SOP to all members of its team, and made sure to do it fairly.
They didn’t distribute SO only to employees who are above a certain hierarchical threshold or who belong to the tech development or sales team. Instead, Fintual created a horizontal scheme, aligned with the company’s own organizational structure.
“The best way to have everyone on the team aligned with what is really important to the company is to give them stock options,” said Stella Melagrano, Fintual’s CFO, on the company’s blog. “We make a great effort to hire and we trust that each one knows what is best for Fintual and to make the company grow.”
The company shared some details of how its stock options plan works:
- It does an annual review to make sure the SOP is up to date based on current business conditions.
- It is earned by all the people who work at Fintual under permanent contracts (97% of employees).
- The number of shares mentioned in the SOP is equivalent to 4 salaries that consider the price of the share when employees entered the company. Simply put: the amount of SO that one earns is 4 times their salary, divided by the price of the share on the day that they entered the company.
- The SOP cliff at Fintual is one year and the vesting is progressive. It is a strategy to encourage employees to stay at least 4 years in the company.
- Fintual estimates the value of the company as a percentage of the amount of assets it manages on the date that each entered Fintual. To calculate the strike price, it divides the value of the company by the total number of shares the company owns.
Things To Take into Account To Create an SOP
There are a couple of key elements that a company should pay particular attention to before creating an SOP:
- How many shares are available to the stock options program.
- The available shares must be enough for all the employees who are currently in the company and all those who will enter until the next investment round.
- The total of shares is limited, which means the more people who earn options, the fewer options each person earns. You have to have an eye to balance both.
- Every time more shares are spun off to employees, current shareholders (non-employees) or founders are diluted. This means your participation will be more diluted.