Why Stock Options Aren’t Actually Beneficial to Employees (and What to Offer Instead)

These days, we’re quick to label everything “great.” There was the Great Recession, which lasted barely a year and a half–not really that great, in the scheme of things. Now, it’s the Great Resignation, though when you actually examine the data, it’s more like a somewhat-higher-than-average resignation.

Regardless, whether it’s to gaze at their navels or to take new positions, a lot of people are leaving their jobs. And that has a lot of other people asking: How do you get them to stay? Now, that is a great question. A recent article in The Wall Street Journal‘s The Future of Everything section posed it to five people in the fields of management and human resources. Their suggestions included more flexible time off, more get-togethers, and a focus on the team rather than on the individual when it comes to compensation and rewards.

What would I say if asked? Well, first of all, of course you should try to foster a strong company culture. Frequent get-togethers help. Working with friends is a powerful incentive to stay at a workplace, though it helps if there’s an actual physical workplace.

But, in my experience, the best way to attract and keep employees has always been to pay more and offer better benefits. I’m betting it will always be so. And of the various benefits, the most interesting, and one that benefits both employee and employer, is some sort of company ownership plan. This is also the benefit that always feels the least understood and is often the most problematic.

At Big Ass Fans, we devised a program early on to motivate and reward select employees whose help was invaluable in building the company. And although the program eventually led to one of the proudest moments of my life, it didn’t work quite as I’d foreseen.

Taking Stock of Options

Most people are familiar with stock options. A lot of startups use them to lure new employees, handing them out like religious fliers on a street corner: Come with us and you’ll be saved!

Simply, stock options give employees the right, but not the obligations, to purchase company stock at a specified strike price, which is usually at or below the market value on the date the options are awarded. These options generally can be exercised at any time after a certain vesting period has expired. Even though employees have to purchase the company stock with their own money, stock options are attractive because they potentially offer a significant return on investment if the company is a success. Of course, “potentially” is key here, because the value of the company can fall or–as is the case with most startups–the company can fail.

A notable example of what can unfold is provided by the mobile-security startup Good Technology. In 2015, the company agreed to be bought by BlackBerry for $425 million after declining an $825 million offer six months prior in anticipation of a more lucrative IPO. But that transaction never happened, as investors got wind of Good’s flagging financial position.

Then things took a poignant turn when news came out of the heavy financial toll endured by its rank-and-file in the sale. Unlike the venture capitalists who invested in Good Technology and received preferred stock, the employees had common stock, and the common was suddenly worth a fraction of its one-time lofty valuation–a fraction, even, of the tax bills paid on that valuation . Some employees who had bought, sold, or traded their shares borrowed money to pay those tax bills. If only they had known a fraction as much about financial security as they did about mobile security.

Too many employees hear the words stock options and swoon. But, to paraphrase Duke Ellington, it don’t mean a thing if it ain’t got that cha-ching, and sometimes stock options aren’t worth diddly. It’s pretty straightforward, but people don’t want to think about the downside. They want to believe they’ll be among the winners who cash in and spend their winters on Nevis.

But there’s a way to do this without forcing your employees to bear the company’s risk–which is to say your risk.

Help You, Help Me

At Big Ass Fans, we provided exceptional employees something quite different from stock options. We designed a stock rights appreciation program that set aside a portion of the authorized stock of my entirely bootstrapped company to be given to employees. The value of each stock’s appreciation rights unit was equal to the appreciation of each share of the company’s stock, measured as the difference between the company’s valuation during the year the unit was issued to the employee and the company’s most recent annual appraisal.

In short, how much an employee’s stock of appreciation rights units became worth dependent upon how much the company’s valuation grew. A third-party valuation firm calculated the value each year on the basis of the company’s historical and current financial performance, its historical and anticipated future growth, and other factors.

The program was set up so that there was no cost, ever, for participating employees. Valuations could obviously rise and fall, but employees would never be out of pocket or lose money, as happens all too often with stock options. Though they could not exercise their stock of appreciation rights at any time during their employment, they would be able to cash out when their employment ended. Because the units vested by percentages over a five-year period after they were awarded, employees were motivated to stay at least until they were 100 percent vested.

In addition, employees were motivated to stay because the longer they stayed, the larger the pot of gold might be at the end of that particular rainbow. And they had further motivation to stay because they would be fully vested, regardless of their tenure, if there was ever a change of control. Which happened when I sold the company in late 2017.

To me, the stock appreciation rights program was a big deal, because from the very start I was asking people to take a trip with me as we built the company. I didn’t want it to be just a job for anyone. The hope was that, in the long run, loyal employees from the factory floor to the executive office would share in the prosperity. That’s a far cry from the way most companies distribute stock options: to executives and managerial types exclusively.

When I decided to sell the company, I determined I wouldn’t sell for less than $500 million, in part to ensure that at least $50 million went into employees’ pockets. Many of them got the biggest bonuses of their lives. Nearly 15 overnight became millionaires, some several times over. This was one of the most gratifying moments of my life.

But, even though things worked out in the long run, that doesn’t mean the program operated exactly as I’d envisioned. The main problem was that the rights program never seemed to motivate people quite as much as I’d hoped. In retrospect, we could have made a bigger deal of it. I think we had only one major event promoting the program. Most of the time, what should have been a killer was simply there in the background, and the valuation was quietly updated every year in a report from HR, a department not necessarily renowned for exuberance. If there’d been a bit more hoopla, maybe people would have been more motivated–and excited. They were plenty excited when the payoff came.

Too many employees hear the words stock options and swoon. But, to paraphrase Duke Ellington, it don’t mean a thing if it ain’t got that cha-ching.

More awareness also would have helped employees better understand what we were trying to do, including how quickly they would vest and how to cash out upon retirement or taking a job elsewhere, though that was a rarity. Our annual employee turnover was only 10 percent. That’s far better than the national average of all businesses, which was about 18 percent at that time.

A Just Reward

At my investment firm, Unorthodox Ventures, we’ve built in different incentives to ensure people are driven to reach certain goals and are well-rewarded when they do. Besides a generous salary and array of benefits–I’ve been called many things, but cheapskate is not one of them–select employees receive 20 percent of the profits from our investments. So if we invest in a company at, say, $2 million and sell our stake for $10 million, we of course get reimbursed for the $2 million that we put in. Those in the bonus pool then receive 20 percent of the $8 million in profit for the effort they put in.

It’s straightforward and easy to track. And because we have investments in a dozen or so companies, it creates plenty of opportunity and plenty of reason for people to stick around. From my perspective, that’s a good deal, because loyal employees are a company’s most valuable asset. They truly deserve to be called great.

From the May/June 2022 issue of Inc. Magazine

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