Tech Company Employee Stock Options

One mildly controversial topic in our industry is whether to provide employee stock options broadly within a tech company. Mind you, this isn’t very controversial in VC-funded companies. The only discussion in that environment is usually about how much and to whom, not whether. But VC-backed companies represent only a tiny fraction of the total universe of tech companies. Providing equity compensation to employees is much more common in tech businesses than in the overall business universe. However, I find that even within the tech community, interest in employee equity participation drops off dramatically outside of the VC ecosystem.

It’s definitely not controversial to me, as I’m a firm believer in the broad use of equity stock options. Below, I’ll state my case:

No one works harder or more tenaciously than owners

I’ve seen entry-level admin assistants with small amounts of employee stock options (a few hundred shares vesting over many years) feel and act like a major part of the team. Willing to go the extra mile. In my experience, teams that believe they have a big payoff with a successful exit are much more highly motivated than those that don’t. Even small amounts of options can cause employees to act like owners.

I guess this is really the crux of the argument. I’ve met some very intelligent people who don’t believe it. Recently, I came across a PhD who was running a very successful company, who didn’t believe “offering equity to employees was the best way to align them with his goals” for the company. It baffles me, honestly. I don’t understand how making everyone feel like an owner DOESN’T best align them with the primary business owner’s goals. Maybe I have too strong an opinion on this topic to do a good job of seeing the other side of the argument. But I really believe that this position of keeping equity exclusive to one or just a few, although it may be sincerely held, is a self-delusion. By someone who really doesn’t want to share the wealth.

Even capitalists need to share for their own good

We’re all capitalists, and I don’t begrudge anyone – especially a risk-taking entrepreneur – who is attempting to maximize their own return. But I believe that in this case it’s being penny-wise and pound-foolish. It comes down to whether you believe that being treated like an owner causes someone to act like an owner. Imo, NO ONE is better for a business than an owner. Indeed, offering options to every employee doesn’t have the same effect on EVERY individual. But I firmly believe that in aggregate, you will likely get the “act like an owner” effect that is so desirable. Also, by using options that vest over years as the equity participation platform, those who leave (either willingly or because they are terminated) will have minimal impact on your ownership pool.

Tech startup equity is the great equalizer

One of the main reasons (at least for early-stage software & hardware companies) to offer broad equity participation via employee stock options is that it’s one of the few areas where you can compete with larger, more established companies for the best employees. Startups generally can’t offer the stability, high salaries, or the best benefits that major corporations can. You’re selling the dream of upstart victory against the odds. The dream fruits of that victory for an employee are an exit event with startup equity options. As I alluded to earlier, what is often misunderstood by those in a position to use startup equity options is how even a modest amount of participation can change attitudes. That is an attitude change from bureaucratic to entrepreneurial. Small amounts of equity can have a huge leverage effect, changing a culture from “me-first” to “we-first”.

It’s important to keep in mind that you still need to hire the right kind of people for your entrepreneurial environment. People who are risk-averse or bureaucratic by nature are likely not good fits. And won’t get the full motivational boost intended by employee stock options. So you need to hire the right personality profile.  AND motivate them to maximize the effects of using startup equity as a major tool in your compensation bag.

Big company employee stock options help keep a small company feeling

Way back when at HP, we had small amounts of employee equity options for select people (not just high-level managers). We also had a discounted stock purchase program and profit sharing. All of these small steps combined to drive employee loyalty. This caused a high percentage (including me) to feel and act like owners. This is a VERY difficult effect to achieve in a huge corporation such as HP was even at that time. In combination with a bottom-up decision-making approach, equity participation provided great leverage compared to other large competitors.

Those competitors had a typically bloated, bureaucratic stereotype that is parodied in Dilbert cartoons, which are close to reality in many cases. The ability to keep a small company culture for as long as possible is highly desirable in my view. Equity participation can play a substantial role in this. Done correctly, it may be the best employee retention tactic of any possible benefit, and will increase loyalty and reduce churn. If structured correctly, employees will feel like they need to stick around at least for another year of equity payoff. And every year thereafter.

Basic fairness – sharing the equity wealth

This part of my argument may not resonate with some. The belief that  “fairness” is paramount in achieving a healthy culture in ANY organization. This is an era where the pay gap between the CEO and the lowest-paid employee in companies is the greatest of all time. I believe now that the perception of fairness is all the more important. Please don’t misunderstand, by fairness I don’t mean “equal”. Everyone contributes at a different level. It’s only fair if those contributions are rewarded differently.

But imo, if a CEO or an executive team is getting wealthy from stock options while their hard-working, modestly compensated staff doesn’t participate in that upside AT ALL–well, that doesn’t pass my basic fairness test. I’ll bet it won’t pass the fairness test of the great majority within the organization. This can have a very CORROSIVE effect on a company’s culture. And ultimately leads to performance regression, which hurts growth and profitability. A popular saying comes to mind: “Pigs get fat, Hogs get slaughtered”.

Stock options aren’t free

I want to recognize that, of course, stock options aren’t “free”. They do have a cost, one which is a bit hidden because they aren’t a “cash” expense. They ultimately do dilute the existing shareholders, in some cases significantly. But I stick to my opinion that if this benefits converts bureaucratic or selfish behavior to team-oriented, owner-like behavior, it’s well worth the cost. This isn’t a theoretical option. I have seen it many times with my own eyes.

That’s my somewhat one-sided take on why every tech company should offer employee stock options to EVERY team member. Many will agree, but many senior tech executives won’t. Post a comment below with your own attitudes and experiences on equity participation.

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