In theory, startup options can make sense for employees given the risk / reward tradeoffs, but the choice is much less simple when accounting for structural elements in option grant fine print. For example, employees typically have 90 or less days to exercise vested shares when they leave the company. This can represent a huge cost for most employees in exchange for no immediate cash gain (unless the startup happens to be in the process of completing a liquidity event).
Some companies have begun to opt into providing significantly longer post-termination exercise periods, but this has implications as well for employees who chose not to leave the company (and future employees), in the form of a gradually increasing dilution of the equity pool.
In an environment where more companies are opting to forego exiting (given ease of raising private money, being profitable but unwilling to deal with public markets, or a host of other reasons), decisions around the structure of an option plan can have big implications. Either unengaged / unqualified employees choose to stick around for a long time if the plan is too strict, or they create a massive dilutive liability if the plan is too lax.
Most startups won’t be profitable at the time an option plan is devised, meaning the founders / executives have bigger fish to fry than to build a complex customizabe option plan that works for every employee. Building a business, hiring, finding a market, and creating a great product represent work that already takes a great deal of time and sacrifice, so even with the best intentions in mind, founders are unlikely to focus on this problem.
Many startup employees don’t know enough about equity compensation (especially stock options) to ask for the provisions which would best fit their individual situation, or to prepare for a given outcome (such as how to pay for vested shares when exiting the company). Perversely, there is a disincentive for founders to help educate employees, as this could reduce the company’s future optionality in the form of fundraising, future hires, the founders’ own compensation, etc. Even if employees were educated on these things, it’s unlikely that the company would customize the offer for any but the most senior employees.
So there isn’t time to build the perfectly complex plan, and there isn’t enough education to ensure employees make the best decisions for themselves.
With a few inputs from a startup’s management, would it be possible for an outsourced manager to create more custom plans for employees?
From the employer:
- Share of equity pool allocated to ESOP
- General comp bands by position
- Value of current common shares
- Known cash risks for the business
- Liquidity event likelihood
- Employee base and hiring rate
From the employee:
- Known and expected personal liquidity risks
- Financial risk tolerance
- Employment lifestage and flight risk
- Business’ performance expectations
Over time could the outsourced manager scalably educate employees and manage custom option plans, from offer through to exercise (including during employee termination)?
Could more commodity management and financial products be offered to employees over time as the outsourced manager scaled?