Employee stock options benefits

What Are the Benefits of Employee Stock Options for the Company?

Stock options offer benefits for both the company and its employees.

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Stock options benefit both employees and employers. Along with two basic types of option plans (incentive stock options and nonqualified option plans), there is flexibility in constructing plan contents. Although available primarily to company senior executives, stock option plans now often exist for many other employee groups. Formerly the purview of larger companies, small business is now also deriving benefits from offering stock options. Businesses receive three primary valuable benefits.

Employee Stock Options Explained.

A stock option is an offer by a company that gives employees the right to buy a specified number of shares in the company at an agreed upon price (usually lower than market) by a specific date. The employee is under no obligation to purchase all or part of the number of shares noted in the option. The choice is theirs alone and they can normally purchase stock at any point during the time period between the offer and last exercise date.

Attract and Keep Talented Employees.

Most companies are painfully aware of the difficulty in attracting talented staff. Just as successful sports teams must “grow” their own talent or attract experienced players from other teams, employers must follow the same path. Top recruiting firms, like Kelly Services and others, and extensive company sponsored searches seek the best available talent, even during down economies. Offering meaningful stock options both attracts better, more talented employees and helps keep them for the long term.

Create More Dedicated Employees.

Employers are constantly attempting to motivate employees and generate loyalty. Volumes have been written about the subject, and numerous “experts” and consultants abound with a wide variety of theories, suggestions and programs. Stock options are a valuable benefit that companies use to create higher level motivation and dedication. It typically works very well, reports Laurie Collier Hillstrom in her article "Employee Stock Options and Ownership (ESOP)." As employees exercise stock options, they usually become more committed to a company’s success. Their stock value hinges on company performance, which, of course, is a direct by-product of employee achievement. Historically, stock options create motivation and dedication for all employees involved as they are more invested in the company and its results.

Cost Effective Company Benefit.

As the cost of all employee benefits continues to increase, companies expand their search for programs that offer high value for moderate cost. Stock option plans often prove to be a strong benefit for employees and cost-effective for companies. While stock options are seldom substitutes for compensation increases, as part of a solid benefit program, they help make employment packages more attractive. The only significant costs to the company are the lost opportunities to sell some stock at market value (since employees usually buy at a discounted rate) and the expense of administering the plan. Added to the ability to attract, keep and motivate staff, the cost efficiency of stock options helps many smaller companies compete with larger organizations by offering comparable benefit programs.

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How do stock options work?

The price the company sets on the stock (called the grant or strike price ) is discounted and is usually the market price of the stock at the time the employee is given the options. Since those options cannot be exercised for some time, the hope is that the price of the shares will go up so that selling them later at a higher market price will yield a profit. You can see, then, that unless the company goes out of business or doesn't perform well, offering stock options is a good way to motivate workers to accept jobs and stay on. Those stock options promise potential cash or stock in addition to salary.

Let's look at a real world example to help you understand how this might work. Say Company X gives or grants its employees options to buy 100 shares of stock at $5 a share. The employees can exercise the options starting Aug. 1, 2001. On Aug. 1, 2001, the stock is at $10. Here are the choices for the employee:

The first thing an employee can do is convert the options to stock, buy it at $5 a share, then turn around and sell all the stock after a waiting period specified in the options' contract. If an employee sells those 100 shares, that's a gain of $5 a share, or $500 in profit. Another thing an employee can do is sell some of the stock after the waiting period and keep some to sell later. Again, the employee has to buy the stock at $5 a share first. The last choice is to change all the options to stock, buy it at the discounted price and keep it with the idea of selling it later, maybe when each share is worth $15. (Of course, there's no way to tell if that will ever happen.)

Whatever choice an employee makes, though, the options have to be converted to stock, which brings us to another aspect of stock options: the vesting period . In the example with Company X, employees could exercise their options and buy all 100 shares at once if they wanted to. Usually, though, a company will spread out the vesting period, maybe over three or five or 10 years, and let employees buy so many shares according to a schedule. Here's how that might work:

You get options on 100 shares of stock in your company. The vesting schedule for your options is spread out over four years, with one-fourth vested the first year, one-fourth vested the second, one-fourth vested the third, and one-fourth vested the fourth year. This means you can buy 25 shares at the grant or strike price the first year, then 25 shares each year after until you're fully vested in the fourth year.

В­Remember that each year you can buy 25 shares of stock at a discount, then keep it or sell it at the current market value (current stock price). And each year you're going to hope the stock price continues to rise.

Another thing to know about options is that they always have an expiration date: You can exercise your options starting on a certain date and ending on a certВ­ain date. If you don't exercise the options within that period, you lose them. And if you are leaving a company, you can only exercise your vested options; you will lose any future vesting.

One question you might have is: How does a privately held company establish a market and grant (strike) price on each share of its stock? This might be especially interesting to know if you are or might be working for a small, privately held company that offers stock options. What the company does is to fix a price that is related to the internal value of the share, and this is established by the company's board of directors through a vote.

Overall, you can see that stock options do have risk, and they are not always better than cash compensation if the company is not successful, but they are becoming a built-in feature in many industries.

For more stock market and investing information, check out the links on the next page.

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