When the investors of a Silicon Valley startup offered company shares to its founders in 1957, a new model was born. In the following decades, employee stock options (ESO) for venture-funded startups began to be offered to all employees and not just founding members.
The options offered to employees were usually in the form of incentive stock options (ISO), which are only available to employees or non-qualified stock options (NSO), which can be granted to employees, consultants or directors.
If the company is successful, then employees can sell their stock for a much higher price after the initial public offering (IPO), when the company is listed on the stock exchange.
A business website builder can help deliver the success to a startup prior to its IPO.
For employees, the benefits are clear. Their stock creates a feeling of ownership that will motivate them to drive success for the company. In addition to this, employees will hope that the startup will reach ‘unicorn’ status ($1 billion in value) and will return high revenues at the time of IPO.
When Google went public in 2004, just six years from its inception, the company was valued at $23 billion. This turned some employees into millionaires overnight, including a former in-house masseuse, Bonnie Brown, who had been paid $450 a week along with stock options that proved worthwhile.
However, this kind of payout is no guarantee for everyone and naturally depends on the success of the startup. Founders are often granted restricted stock awards (RSA) with more favorable terms, while later employees may be offered restricted stock units (RSU), for which the strike price determines the rate they need to pay.
Early employees may also be offered shares at a much lower rate than those who join later, and their value could be dependent on seniority and performance.
As the median period employees work at startups in two years, the company is more likely to float on the market after the employee has left. Unlike venture capital, employees do not have pro-rata rates on their stock. This means they can be devalued over time.
Investors and founders are finding it more profitable to take the company to IPO after a longer period, typically around 10 to 12 years, when a higher value can be reached on the market.
For the employer, the model of employee shares can help raise morale in the workforce and create loyalty, as staff are more committed and involved in the direction of the enterprise. In many sectors, such as technology, talent is crucial to the success of a startup.
This is something that can be attracted by the right share schemes for employees. For startups without available funds, stock options can be a welcome alternative to paying high employee salaries.
But today venture capital funds are more readily available, and they can offer startups the revenues they would have received at IPO in past years. This means that employers do not need to grant such potentially lucrative stakes when they can be held by the founders and the investors, or sold at each round of funding before the IPO.
Compared to the dotcom period, stock options are becoming less attractive to employees and less necessary for employers.