Ever since the big US biotech’s started offering employee stock options, it has become an increasingly popular way to boost employment packages for new hires and existing employees alike. Here we take a closer look at how stock options work and how life science companies can use long-term incentive plans as an effective way of not just attracting talent, but also improving employee retention.
What are stock options?
Stock options are a way of compensating employees. They are contracts that give an employee the right to buy or exercise a set number of shares of the company stock at a pre-set price. It is usually a benefit given by innovative start-up and scale-up companies in order to reward early employees when and if they go public. They are also a common incentive offered by fast-growing businesses to encourage employees to work towards growing the value of the company's shares. Stock options offer workers a slow burning way to make money that encourages them to stay at the company for a long period of time.
What are the benefits of offering stock options?
Competition for talent with specialist skills and experience is fierce. A good candidate in the life sciences industry is likely to have many attractive offers on the table. Offering stock options can put you ahead of the competition, especially if you are an early-stage company with a lot of potential. Some candidates may be put off joining an unknown start-up if they perceive it as a career risk, so it is crucial you make the employment package as appealing as possible. Offering stock options provides candidates with another financial incentive to join the company, and crucially, makes them feel a part of the business they will be helping to build.
Having a piece of the company’s ownership means its success – and valuation – is felt more directly by its employees. This can motivate your team to be more productive and give greater discretionary effort towards pursuing the best outcome for the business, rather than directing their efforts solely towards their personal targets and career progression.
As they cannot be exercised immediately, stock options can incentivise employees to stay with the company for longer, rather than walk away from a sizable pay-out if they choose to leave before the option contract has matured. If a company is growing fast, stocks can have serious value and other companies will struggle to lure them away no matter what salary and benefits they offer.
What stock options can you offer employees?
Restricted stock units (RSUs)
Restricted stock units are given to an employee when they join the company, they will also usually be given more units around bonus or appraisal time. The employee will own that share unit (these will either be in monetary value or in share units).
Restricted stock units are issued to employees through a vesting plan, which can last for several years, in which time they cannot be sold. Capital for the total value of each share can be accessed after the vesting period. The employee doesn’t have to sell their units during the vesting period, if they hold on to them they could increase over time. But if an employee does decide to sell their shares, it is subject to capital gains tax and in some countries its taxed just like income.
These are usually offered by more established businesses who have commercial products on the market as their stock is inherently valuable and less subject to fluctuation on the stock market so it will have a high value regardless. RSUs are often an attractive prospect for businesses as they are an inexpensive way to reward employees. They are also very attractive for employees as they are nearly always worth something, even if the stock price drops dramatically.
With share options the employee owns a number of options. A grant date will be set where the employee will be given the option to purchase shares. The value of those options is based on the value of the shares at that point or a given price, this is known as strike price. If the employee exercises the option when the share has vested, they will only receive funds if the value of the stock is higher than the price that they paid for it. They will only be entitled to the profit as they do not own the whole share. These are usually offered by earlier stage companies and offer less certainty for employees than RSU.
Profit share schemes
In profit share schemes employees are entitled to a share of the company’s profits. The amount each employee will receive depends on the number of people in the scheme. This option is usually common in private or family-owned companies.
SAR (Share Appreciation Rights)
Share appreciation rights, also known as SAR, are linked to the company's stock price over time. The SAR are profitable for employees when the company's stock price rises. With this option the employee does not own the share or stock, instead they are given a nominal number of rights on the company’s discretion. Share appreciation rights are paid the same as income and are therefore subject to income tax.
In summary, stock options can be an effective way of attracting highly skilled employees and retaining them for longer, as they financially incentivise option holders to stay the course and work towards the long-term success of the business. Stock options are best suited to small companies where future growth is expected, or for public companies who want to give employees some form of ownership. They can be very cost-effective and help motivate your workforce to achieve more and be more efficient, making them beneficial for all parties.
For more helpful advice and tips on how to attract and retain talent check out our latest blogs, infographics and guidebooks.