Scaling up? Here’s when an option plan can help
This write-up was originally sent to subscribers as a part of our Mission Control weekly insights, a series where we share wisdom and quick breakdowns on topics from our entrepreneur support network.
As your startup scales, attracting and retaining top talent becomes a key part of your success. Offering stock options is one way to align your team’s long-term incentives with your company’s growth, but when is the right time to introduce a stock option plan?
Let’s dive in to the key considerations for adopting a stock option plan—whether you’re expanding your team, raising funds, or already experiencing significant growth.
When To Consider Options
Stock options are different than the common stock (also called restricted stock) you have likely issued to the founding team and some very early team members or advisors. Issuing common grants in the early days is good to keep company costs low but once you start making progress you’ll want to switch to options for their flexibility. This enables you to attract and retain talent while keeping your cap table clean. The inflection point for switching to options is when the valuation of the company has grown whether through funding or revenue, or the company is gearing up to expand.
Here are more details on when it’s time to transition from stock grants to an option plan:
1. You’ve raised more than $50k or your revenue is growing quickly: If you’ve raised more than $50k or have similar amounts of revenue, the idea that your startup’s stock is still worth the same price it was at formation doesn’t hold. The standard practice is startups incorporate with a low share value, $0.00001 for most startups—that’s what we incorporate companies with at Gust Launch. Once you are past that funding or revenue threshold, common shares should be granted at a higher value but that means you’d be asking your new team members to pay you non-trivial amounts for their equity. Have you ever taken a job only to pay the company up front? That’s not the kind of incentivisation most people joining startups have in mind. With stock options, employees don’t have to pay up front for them, only later when they are hopefully worth far more than the initial price.
2. You’re preparing to hire employees / your team is growing: If you’re adding a lot of new team members that will be a lot of small equity grants. If they are all common shareholders on the cap table you have to get votes & provide notice to all of them for various corporate actions. Additionally, common grants with vesting schedules—which all should have—come with 83(b) elections every employee would have to make sure they understand and file. Since options are not immediate ownership neither of the above apply. The company has less governance burden, and the new employees aren’t mired in paperwork.
3. You’re planning to fundraise: Investors often like to see a stock option plan in place and they will make the creation of it part of the negotiation if none exists. Having one already in place with a clear hiring plan shows that you’re thinking strategically about long-term growth and team retention. Hiring is a big part of the use of funds so having a clear plan that justifies the fundraise helps add credibility.
How Stock Options Work
When employees receive stock options, they’re granted the right to purchase shares at a fixed price (the “strike price”) sometime in the future. They typically vest over several years, which incentivizes employees to stick around as the company grows. Once exercised, stock options can convert into real shares, allowing your team to benefit financially if your startup takes off.
But stock option plans come with a few costs and administrative responsibilities, notably, an annual valuation of the company to set that strike price. You generally don’t want to set that yourself so you get what is colloquially called a “409a valuation” and that has to be updated every 12 months. Additionally, if you’re not using a streamlined corporate governance and cap table solution like Gust Launch—which also includes 409a’s—you’ll have to have a lawyer draft up the adoption docs and templates.
Adopting a stock option plan is an exciting milestone in the life of a company but navigating the timing and appropriate kinds of incentives to rally your team can be nuanced. “Is this an advisor or a contractor? Am I ready for employees? What are appropriate vesting schedules for a part time team member that intends to go full time later?” and more are common questions.
We can help with that! Check out Gust’s Mission Control acceleration platform. It’s equity-free, packed with education, real human support, and great software tools (including super discounted Gust Launch). To get an idea of the expertise on offer, check out this session all about early equity.
Gust's Mission Control can guide early founders through all sorts of complex startup hurdles and provide access to startup greats like Ryan.
This article is intended for informational purposes only, and doesn't constitute tax, accounting, or legal advice. Everyone's situation is different! For advice in light of your unique circumstances, consult a tax advisor, accountant, or lawyer.