Key Points Companies May Consider When Drafting an Employee Stock Option Plan

An employee stock option plan outlines the guidelines, restrictions and requirements that companies use to administer and grant employee stock options. This article reviews considerations companies may use when formulating their stock option plans. Companies may discuss these considerations with their legal and tax advisors.

Two Key Types of Stock Options

There are two key types of stock options that companies most commonly offer to their employees.

• Non-Qualified Stock Options (NSO). NSOs are one of the most common type of stock options and they give employees the opportunity to buy shares of company stock within an established period of time. They do not receive preferential tax treatment and are taxed as ordinary income upon exercising the stock option. This is often the option type that is available to employees and may also be issued to non-employees such as consultants or contractors. 
• Incentive Stock Options (ISO). An ISO gives an employee the right to buy company shares at a pre-determined price with the potential for preferential tax treatment, if the employee meets certain holding requirements. ISOs are often awarded to executives, top management and other high-level employees. More complex than an NSO, ISO’s may be difficult for the employee to manage due to the time-based holding requirements that must be satisfied to get preferential tax treatment.

Steps Companies Consider When Formulating Their Stock Option Plans

• Determining Who is Eligible - Most companies work with their legal counsel to determine who is eligible for equity compensation. This may include which roles and what level of seniority is required to be eligible for the stock option program. They may discuss how this will affect company culture and how it will incentivise both current and future employees.
• Option Pool and Dilution - The option pool refers to the shares of stock that are reserved for a company’s equity compensation plan. When determining the size of the option pool, companies may consider how this will affect dilution of founders’ and other shareholder’s stock. 
• Vesting Schedules - A vesting schedule determines when options, awards and other stocks are available to an employee. This is often based on time with the company but may also include other future targets such as company growth and performance.

Choosing an Equity Management Platform

An equity management platform has many features that help service an employee stock option plan. Companies who use spreadsheets to manage their equity plan may find them to be time consuming with conflicting cap table versions and data security issues. As spreadsheet management becomes increasingly antiquated, an equity management solution can help you automate and organize many of the complex processes of executing a plan and help ensure the integrity of your plan.

• Everything in a Single Place - A good equity management solution keeps equity records in a single place. This includes shareholder records, valuation data and expense reporting. When it comes time for expensing, reporting or auditing, you’ll have the data you need and will be ready to go.
• Record Keeping – It’s key to maintain good records when running a successful stock option plan. A good equity management solution records vesting schedules, exercise dates, cap table versions and other important data. It also keeps a transaction history which is vital to tracking the origin, history and changes to a stock certificate.
• Communicating with Shareholders - One of the biggest challenges when managing an equity compensation program is communicating with shareholders. A good platform helps you issue and track grant agreements, allows shareholders to exercise grant agreements online, and provides supportive communications to help shareholders understand the value and status of their compensation.
• Reporting - Reporting is an essential part of managing an employee stock option plan. Reporting will help you track engagement with the plan and will help streamline your audits and stock expensing. Look for a solution that has the reporting capabilities to meet your growing company’s needs.

Shareworks Equity Plan Management 

Shareworks by Morgan Stanley has helped thousands of companies with the administration of their stock option and equity compensation plans. Our clients include startups, emerging companies and global public companies, such as Uber, Dropbox and Atlassian. We welcome the opportunity to show you how Shareworks can help you solve your equity plan management challenges.