Ownership is important to employees. Here’s why stock options may not be the best way to give it to them.

Claire Shefchik

April 5, 2022

Ownership is important to employees. Here’s why stock options may not be the best way to give it to them.

April 5, 2022

Ownership is important to employees. Here’s why stock options may not be the best way to give it to them.

Employers and employees alike agree that having ownership in their company — having a “founder mindset” — is one of the most powerful ways to increase engagement, loyalty, and productivity. More than half of respondents under 35 in a 2019 survey said that ownership or stock is important when considering a job change. Traditionally, for startups, “ownership” meant stock options in which employees are given the opportunity to buy company stock, which increases in value as the company grows. What could be better than owning a piece of a company they’ve put such hard work into? In fact, the changing business landscape means those stock options may not be the best deal for employees anymore. More and more companies who offer equity are starting to consider it from their employee's point of view and offer alternatives, such as restricted stock units (RSUs). Here’s why: 

1. The risk may be too great.

Stock options can be risky for employees, even if the price goes up. For example, if an employee enters a company and its stock is worth $20 per share, they’ll buy stock options for that price. If the company is then sold at $40 a share, they’ll only get the difference between the prices. Alternatively, a restricted stock unit is a promise from a company to give employees a share of stock; or in other words, a stock option with a strike price of zero. The employee pays nothing upfront. And as long as it has a value above zero, an RSU won’t become worthless. 

2. They may have tax concerns.

With inflation soaring and the cost of living rising, employees are keeping a closer eye on their tax bill, so they might be concerned about getting hit with a big tax bill prior to the company being sold – not to mention extra piles of paperwork come tax time. When employees exercise stock options, they’re taxed as regular income, as are RSUs. However, RSUs are connected to certain events, such as a new funding round, which helps employees with tax planning. And RSUs don’t become taxable until they’re vested, which is simpler for employees, and often means the company has proven its worth when they are received. 

3. The balance has shifted. 

“Investors and founders have changed the model to their advantage, but no one has changed the model for employees,” wrote Steve Blank, professor at Stanford University and founder of multiple companies. With multimillion-dollar seed rounds, founders risk less than they once did and can often find ways to cash out early. Further, founders often grant themselves restricted stock awards instead of common stock options, which essentially allows them to buy the stock at zero cost. And while venture capitalists often use pro-rata rights to keep their percentage of ownership intact, employees don’t have that option. RSUs give employees a fairer deal since they are linked to events that demonstrate success. Employees have confidence that they will share in that success equally.

4. The landscape has changed.

Although the entrepreneurial spirit is strong as ever, companies are staying private longer. The number of publicly listed companies dropped by 52% between the late 1990s to 2016. In some cases, increasing regulation and risk has made the rush to go public less attractive. Now, companies may not go public in time for the employee to cash in their options. Research shows that the median tenure for an employee between ages 25 and 34 is just under three years. Employees want to feel ownership in the organization, but they don’t want to feel tethered waiting for an IPO or sale that’s far off on the horizon. 

Offering ownership is still one of the best ways to engage employees and give them a “founder mindset.” But these days, that means looking at it from their point of view and considering the best options for them.