A wise man once said, “it’s important to do things right from the beginning rather than fixing the mistakes later.”
And this term directly applies to the designing of stock options. If you design your start up’s stock options “right” from the beginning, then there won’t be any “fixing mistakes” later.
You will not have to deal with legal exposures, fines, upset employees, or whatever! Only if you do this one thing right.
For this reason, we came up with this simple and super easy guide on how to design stock options for your startup.
Initial Setup
Before you do something, you have to plan or come up with a setup.
The first step to designing stock options is to make an upfront investment to issue options to your first set of employees in the startup.
Here are a few steps to do just that.
1. Come Up With Your Company’s Philosophy
You need to build a proper philosophy for your company before you start anything. Keep in mind that this philosophy is how you are going to attract your future employees.
It is best if you develop the stock options philosophy in discussion with your Co-Founders, advisors, or board. This allows for the exchange of ideas and different perspectives, which help make a stronger philosophy.
Think about how much of the company you wish to share with your employees.
What percentage of share in the company are you willing to keep for your employees?
How about rewarding employees who join in later?
The Standardization of your grants and cash versus equity compensation.
You need to come up with a proper philosophy for all these things because these are the things that build the foundation of your startup.
2. Paperwork
Now that you are done with the philosophy, it is time for some paperwork!
So, take you stock option’s plan and agreement documents to both the stockholders, and the board to get their approval. That’s it, you’re all set.
The paperwork can cost you as little as $200; you just need to find out a reliable source such as Clerky.
3. Make Things Official
Communicate and work with your layers to get all the state permits relevant to your optional plan.
Also, know that the employee stock option regulations may vary from state to state. For that reason, you have to check out your state’s regulations and do things as needed.
Maintaining Your Stock Options
Now that you’ve come up with the setup let’s call it the initial skeleton of the stock options for your startup, you need to be able to maintain it.
Maintenance is very important not only to help your startup grow but to keep your startup from falling off as well.
You will need to monitor some of the items on a daily basis.
1. Be Updated on Your 409A Valuation
In case your valuation is 12 or more months old, you immediately have to renew it. You also have to renew your 409A valuation if you’ve hit a significant milestone, be it related to finance, sales, or products.
Remember that the 409A valuation lets you evaluate the exercise price for stock options to meet the IRS guidelines.
2. Equity Budget Creation
Another thing that you will need to take into consideration when maintaining the stock options for your startup is to design a hiring plan until your next funding event.
Think about the total number of stock options needed to compensate for the new employees.
3. Create a Stock Option Pool
The next step is to make sure you create a stock option pool of the right size. You will need the approval of the board and stockholders to do this.
4. Tracking Your Stock Option Pool
You also need to keep a strict check on your stock option pool. In fact, you should monitor your stock option allocation from time to time to ensure it is sufficient enough for hiring employees in the future.
If your stock option allocation is going well and you have enough pool to make room for new employees, you’re good to go.
However, if your stock option pool is not sufficient for the future hires, you will need to make, it is time to raise this issue with your board, discuss, and consider re-planning.
If everything’s going well for you at this stage, you’re ready to make grant offers to your prospective employees.
Making Offers to Prospective Employees
If you have got enough allocation in your stock option pool, congratulations! It means you’ve done a great job so far.
You will now be making grant offers to your prospective employees.
1. Check Your Budget
Just to be on the safer side, check your budget every now and then before you make a grant offer to any prospective employee you wish to hire. Check if you even have the necessary number of unallocated shares available in your pool to cover the offer.
Many people make a common mistake of offering shares to the employees when they have no balance left in their shares. This can create serious issues, and the cost of repairing this mistake is very high. It can also cause legal issues for your startup.
2. Confirm The Employee’s Details
Make sure that the employee can legally work for you. If they are not a citizen of your country, you may need to check their visa and residency.
This is an important step that needs consideration.
3. Check The Size of The Grant And Deliver It
If any of the new employee’s shares in the company exceed, 10% must have a strike price, which is a total of 110% as per the 409A price-per-share valuation, not 100% as usual.
Once you’ve checked the grant’s size, it is time to deliver it to your employee.
Provide an offer letter, that includes the details of their grant, to the employee. You must provide this grant in the share numbers, not in the percentage of the company.
The letter should also state a clear note that the amount of grant and the exercise price is subject to the approval of the board.
You must be issue your stocks under the limitations of Rule 701.
Grant Finalization
This is just a finishing step where you have to take care of some legal things.
If your current 409A is still valid (less than 12 months old) and there has been another valuation event, no action is needed. In case, a new 409A valuation has occurred since the last board meeting, then the board needs to review and approve it.
Ensuring that the board approves the employee’s stock option grant in the next board meeting in case there are any material differences from your company’s standard offers.
The cap table of the company should be updated regularly with the details of the new stock option grant.
Designing well-planned stock options for your company is very crucial. It can help you hire amazing employees and reduce the chances of risks and missteps that can cause a significant damage to your startup.
One of the most significant things to do along with these four steps when it comes to designing stock options for your startup is managing the information correctly. Track each and every step your take and plan accordingly.
We hope you found this guide useful, and it gave you the right information you needed to design and maintain the stock options for your startup.
