We wrote about “The Why, How and Who of Including Equity in Your Comp Plan.” Now that you’ve decided to offer equity, remember this: The whole topic of equity and stock options is somewhat complicated and potentially confusing, so be sure to be transparent and clear when communicating about it with your employees.
When you’re talking about stock option grants, there are different ways in which it can be explained, so use those different ways appropriately. To break that down further, one of the ways is to tell them the number of shares they’re being given. That number is fundamental, because it doesn’t change. If an employee is given 5,000 shares, then that number will stay 5,000.
A second way you can communicate it is by the percentage of the company. Does their grant represent 1% of the company or 2% of the company? It’s important to be clear that the percentage will change over time. It’s not static like the number of shares; it changes because of dilution. But it’s still a really important way to communicate the grant to employees — especially to senior management teams and key hires who often think about equity grants as a percentage of the company.
A third way is communicating what the value is — the actual monetary value to that employee. That’s what they’re going to end up with, so that’s what really matters most to them. But when you’re communicating about this, be clear that it is subject to risk in future valuations. While value is a good way to sell the upside about joining the company, you simultaneously want to warn them that the reality may well unfold differently.
I suggest you present the detailed terms of the grant to the employees in a summary sheet. This would include the grant date, the number of shares, the divesting schedule and the strike price. You could also include the percentage of equity for the current point in time and potential value as an example, but be sure to stress that it’s just at this point in time, and it’s subject to change. Download a summary worksheet here.
Explaining the value of shares to an employee can cause confusion, so you may want to use an example: Let’s say you give 2,000 shares at a strike price of 20 cents to an employee, and you know you had a recent fundraise with investors where the company was valued at $20 million, or $1 a share. Communicate to your employee that the value to them today would be 2,000 shares times $1 minus the 20 cents they paid for it, which is basically 2,000 shares times 80 cents. So that’s $1,600.
Especially with key hires and senior management staff, you also want to communicate the future valuation. Build this into a dialogue around what your future plans are for the company, including what you expect the future valuation to be and the impact of expected dilution. Use those numbers to explain the future potential value to the employee. For the same example as above, let’s say you want to achieve a valuation of $300 million with an expected dilution of 20%. Then the expected future value of each share would be $300 million divided by 20 million shares times 80% (because of your dilution). That gives you $12 per share. So the potential value to the employee of that same share grant is 2,000 shares times $12 minus 20 cents strike price, which is $23,600.
I can’t stress enough the importance of communicating the caveats: “While the expected value is XYZ, we don’t know that for sure, and it might not materialize that way.” Also note that the percentage of the grant they’re getting could change and reduce over time because of dilution.
If you’re going to use equity as part of your comp plan — and you should — be sure you are effectively communicating about it to your employees. If you need assistance with your equity-communication plan, please ask me. I’m happy to help.