Offering employees stock options is a fantastic way for companies to reward employees and develop a motivated and creative workforce. An employee stock option is an offer by a firm to buy a certain number of its shares at a specific price (often below market) and by a certain date. Employees and employers pre-agree on the number of shares they may purchase and the length of the vesting period before they buy the stock. The contract that both parties sign contains all of this information.
The option does not obligate the employee to buy all the specified shares. They can often buy stock anytime between the offer and the last exercise date, and the decision is entirely up to them. Every employee need not receive stock options, and many companies decide to reserve them for a select group of essential positions.
Types of employee stock options plan (ESOP)
Employers issue stock options per the stock option compensation plan. If the market price is higher than the exercise or strike price, employees can exercise their options and make an in-the-money trade. The corporation issues shares to the option holder after the stock options are exercised. The total number of outstanding shares, as a result, rises. Consequently, earnings per share (net profit/number of outstanding shares) declines with increasing denominator.
Exploring the many types of employee stock options plans helps to clarify their meaning. Employers have several options for giving employees stock ownership, including:
- Employee Stock Purchase Plans (ESPPs) are programs where employers distribute shares to staff members who meet a minimum service requirement. Then, they sell them for a significant discount off the going rate.
- Employee Stock Option Schemes (ESOS): this is a program where employers provide options based on a pre-determined valuation. This is effective regarding the vesting term and employee overall performance. Employees can exercise their options at the pre-determined strike price as soon as they reach the minimum vesting period.
- Restricted Stock Units (RSUs): employers give employees business shares with no set vesting schedule or exercise price. The latter, however, can only use the right to the shares when a local event takes place.
- Stock Appreciation Rights (SARs): SARs may or may not qualify as an ESOP. This is because few businesses prefer to pay employees cash in return for shares once they fulfill specific requirements.
How are stock options implemented?
Below is an illustration of the full stock option process to help you comprehend how stock options work in a corporation:
During the early stages of their business, Walter Holdings employed Russell Walker as a manager. Russell can purchase 25,000 shares of Walter Holdings stock for 15 cents per share under the provisions of his employment contract. According to the agreement, Russell’s stock options have a four-year cliff-to-cliff vesting term.
This indicates Russell will be eligible for one-fourth of his shares after a year at Walter Holdings. He could purchase 6,250 shares at 15 cents per share for $937.50. The remaining 18,750 shares would then vest gradually over the following three years. His options are unavailable if he quits his employment before the one-year cliff.
Russell will hold a small portion of equity in the company that he can sell to others once he has exercised all of his shares. He has a four-year option to purchase all outstanding shares. Russell can resell the shares he bought for a profit if the business succeeds and the shares sell for $10 each.
Reasons to offer employees stock options
Increase the number of devoted workers.
Employers make ongoing efforts to inspire loyalty in their workforce. There have been a lot of books written on the issue, and there are a lot of “experts” and consultants who have offered a wide range of theories, recommendations, and plans. Companies employ stock options as a significant perk to foster higher motivation and dedication.
Employees typically grow more dedicated to a company’s success when they execute their stock options. Their stock value depends on business performance, which directly results from employee success. According to research conducted by the Boardroom ESOP division, stock options have historically increased motivation and dedication for all personnel concerned because they make them feel more invested in the business and its outcomes.
Recruiting and retaining talented employees
Most businesses are acutely aware of how tough it is to find talented employees. Employers must adopt the same strategy as successful sports teams to “grow” their talent or recruit seasoned players from other teams. Giving employees valuable stock options helps retain them over the long term and attracts better, more skilled workers.
Affordable company benefit
Companies continue to look for programs that provide high value for a low cost as the cost of all employee benefits rises. Stock option programs are frequently cost-effective for businesses and a great employee reward. Although employee stock options rarely replace pay raises, they make employment packages more enticing when they are a component of a strong benefits package.
Since employees typically purchase shares at a discount, the only actual expenses to the corporation are the missed opportunities to sell part of that stock at market value and the cost of managing the plan. The cost-effectiveness of stock options helps many smaller businesses compete with larger enterprises by providing comparable benefit programs and the capacity to draw in, retain, and motivate workers.
Employee stock options can also offer protection for employers through the requirement that the employee has to work for the company for a specific amount of time before being granted access to their stock options. This helps keep employees on board longer and protects the company’s equity.
The sum up
Employee stock options allow employees to purchase business shares at a pre-determined price after a pre-determined amount of time. In addition to their usual compensation, employees who own stock have a financial incentive to perform well at work. They want to contribute to the company’s expansion so that the stock price will increase and they can significantly increase the value of their initial employment benefits.