How to Offer Stock Options to Employees

Offering stock options to your employees can be a powerful incentive. In a way, you're making them partners, who are personally invested in the success of the business.

Instructions

1. Know that a stock option plan is not the same as an employee stock ownership plan, or ESOP.

2. Know that companies generally grant two types of options, those that meet Internal Revenue Service standards for preferential tax treatment and those that don't. Options accorded tax breaks are called incentive stock options, or ISOs; the others are called nonqualified stock options, or NSOs. Both types of can be granted to any employee.

3. Consult a certified public accountant before you decide how many options to grant, who will get them, and which type of options you will grant.

4. Get an appraisal of the company, establishing its fair market value. This will enable you to determine the value of stock to which options ultimately are tied so that you can determine the exercise price of the options.

5. Develop the stock-option plan several years before the company plans to go public. This will enable you to grant options at a relatively low exercise price. As the company's value rises, the exercise price can remain low, potentially making your employees wealthy.

6. Plan to grant options that will have a duration of five to 10 years.

7. Make provisions for employees who leave the company before the initial public offering (IPO) takes place.

8. Decide whether you will compensate employees in the event the IPO never occurs.

9. Develop a buy-back agreement. As employees cash out, the company will get the first shot at buying their shares.

10. Use stock options as an incentive for employees to work efficiently and achieve production, sales or other goals.

Tips & Warnings

• Avoid granting options immediately before the IPO.

• Make sure employees appreciate what the stock options represent. Most employees will have no idea of the potential value of the options.