Stock options are a type of financial incentive that can be used to reward, incentivize, and retain employees. A stock option is a contractual agreement between an employer and an employee that gives the employee the right to purchase a specified number of company shares at a fixed price for a specific period time. Theoretically, if the company’s stock price increases, the employee can purchase the stock at the predetermined price and make money on the difference.
Because stock options give the employee the potential to profit from an increase in the stock price, employee stock options are a popular and effective way to incentivize and motivate employees. By offering employees the opportunity to share in the rewards if their efforts help to increase the companys value, they are incentivized to work hard and make investments in the companys future.
In addition to providing a monetary incentive, stock options are also used as a retention tool. In many cases, stock options offer employees an incentive to stay with the company instead of leaving to pursue other opportunities. This makes sense because if an employee leaves the company before their stock options are vested, they can never realize the potential rewards.
When setting up an employee stock option plan, there are two primary types of options the company can choose from. Non-qualified stock options offer employees the ability to purchase a fixed number of shares at a predetermined price for a specific period of time. Once the option becomes vested, the employee can exercise their option, thus buying shares at the discounted price and selling it on the market for a profit.
The other option available is known as an incentive stock option, often referred to as an ISO. These offers employees the same discounted price, but with ISOs the employee does not have to pay any taxes on the profit that is made when the shares are sold on the market.
When setting up a stock option plan, it is important to make sure that it is structured in such a way that the company will experience a positive impact when the options are exercised. This means that at the time that they grant the option, the current market price should be lower than the exercise price, so that when the employee exercises the option, the company will gain the difference.
In some cases, companies will also set up Stock Appreciation Rights (SARs) plans that provide employees with the ability to realize a profit equal to the difference between the current market price of the shares and the predetermined price of the option. With SARs, employees are not given the actual stock; instead, they receive a cash payment that is equal to the difference in value.
Regardless of which type of stock option plan is chosen, companies must ensure that the plan is set up effectively and complies with all applicable laws and regulations.
Overall, employee stock options can be an effective tool for retaining and motivating employees. By encouraging employees to work hard and remain with the company, stock options can help to increase the value of the company and also reward employees for their efforts.
