How to Give Employees Stock Options: Tips From Founder to Founders

16 May 2024

About 80% of the team at my early-stage startup have stock options. These talented individuals could have chosen to work for big-name companies if I hadn’t made them co-owners.

For startups, offering options to employees is the most effective approach to attract talent. When you're small, it's nearly impossible to match the salaries paid by tech giants like Google, Microsoft, or Netflix. What you can provide is ownership in a potentially multi-million dollar company.

If you're a fellow founder, you've likely already googled how to issue stock options. Here, I offer tips from my own journey.

Show $$$ but Explain Risks

When I hire people, I offer them three choices: no stock options and a higher salary, a middle-level option, and the highest possible option at a lower salary.

For me, it's a positive sign if a potential employee accepts an option for compensation. It means they aren’t just interested in making money but also in my startup’s product, and they will do their best to make the company successful.

To get employees interested in the stock option, you have to explain your startup idea to them (just like when you talked to investors). Prepare your pitch; describe the opportunities and risks.

Stock options allow employees to buy company shares at a fixed price (the strike price) and potentially sell them at a much higher market price later. This can lead to big financial gains if the company's value goes up. Provide concrete figures when discussing this with employees.

If the startup becomes very successful and is bought for $200M, the employee who had 1% of the option receives $2M. Saying “two million dollars” can serve as a strong selling point.

But startups often fail, and yours may too. And the stock options might end up being worthless. It is crucial to prepare the team for this scenario, making sure everyone understands the terms they are agreeing to. Managing expectations is one of the most critical aspects of effective management. Sell, but don’t oversell.

Don't Get Greedy

I have allocated 15% of my startup’s total equity for the employee stock option pool, a rate considered optimal. Each employee receives between 0.2% to 2% of the options. Go through the checklist below to try to see the fairest way to issue stock options:

  • Consider the employee's market salary and/or their requested salary.

  • Determine the amount you are willing to offer as compensation.

  • Compensate the difference with stock options based on the estimated company valuation during the next round.

Don't skimp on employee stock options — you are aiming to attract the best talent in the market, so come up with a fair compensation.

Evaluate the employee's role, responsibilities, and contributions to the company. Roles with significant impact or employees who notably contribute to the company's growth and success typically receive a larger share of the stock options than others.

Senior software engineers, along with elite marketing professionals like CMOs or heads of sales, are instrumental in driving product development and attracting customers. Their expertise is not only crucial for engaging customers but also for appealing to investors. Given their significance, specialists like these can effortlessly be entitled to up to 3% of the total option pool.

Regularly review and adjust stock options as the company expands and develops. What may have seemed like a fair allocation in the early stages might need modification as the company scales and hires more people.

Establish Vesting Rules

To align your interests with those of your employees, promote long-term commitment, and ensure that equity is earned gradually.

First, determine the total duration for which equity will vest. While the standard vesting period is typically 4 years, this timeframe can vary depending on the specific circumstances.

Consider implementing a "cliff" period where no equity vests until a specific milestone is reached. In our startup, we incorporated a 1-year cliff. This approach allows sufficient time to assess an employee's performance and track progress. After that year, an employee receives the initial portion of stock options, around 25%, and then the shares vest monthly.

Clearly communicate the vesting rules to employees in their offer letters, employment agreements, or equity grant agreements.

Documenting the vesting rules is crucial to prevent misunderstandings later on. Besides, having a structure for the employee option pool is important during the funding process: Investors will certainly examine whether you have established clear rules.