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Equity Compensation: I Have the Cure You Seek!

Is your equity program on the fritz? Are your stock options in the dump? Could your RSUs use a bit more pep? Are your stock appreciation rights feeling a bit more like wrongs? I have got the cure for what ails you! Like the snake oil salesmen of yesteryear there is always someone pitching some unique feature or approach that will solve all of equity compensation’s potential problems without having any side effects. And, just like the people who purchased those sometimes poisonous and sometimes pointless solutions, the buyer had better beware!

Welcome to another installment in my “Stock Options on the Precipice” series. Let’s hope I finish before things go over the edge! Other articles in the series can be found here: 1, 2, 3, 4.

My guess is that those long-gone concoctions probably had one or two real uses and hundreds of purported uses. The trick was knowing which was which. I am sure that there were probably some decent furniture polishes marketed as cures for the vapors. There were probably some drug-enhanced flavored syrups that were marketed as a cure for “tiredness.” This happens any time people are feeling desperate and the topic is hard to understand. People sell ideas that were designed to do one specific thing as cure-all solutions for every problem.

Equity compensation drives these types of “search for a cure” every three to five years. The market turns, new regulations get rolled out, or the tax regime changes and companies, investors, plan participants, politicians or the media start calling for equity compensation to be “fixed.” In response, solutions and bad ideas spring up all over the place.

I will cover just a few of these combination solution/bad ideas currently being bandied about and some of the doozies from the past. But, pay attention, because all of these ARE solutions for some companies and ALL are bad ideas for others. The key is understanding your company’s needs before you start slugging down mouthfuls of potential poison.

Idea 1: Extending the post-termination exercise period to be the full life of the grant. There is a story about a company named Amplitude and how they transformed their equity in two steps. Post-termination life extension can work in limited situations, but if you are going to be around a while, expect to get additional rounds of financing or will require a very large staff before your liquidity event, then this is likely to be a pretty bad idea. How will you be able to provide grants to a new officer if an old officer leaves and keeps his equity position? How many investors want to invest in a company with a cap table that may have thousands of individuals? How will you have any equity left for employee number 2500 if every former employee is still holding his or her old stock options?

Idea 2: Formulaically granting equity on an annual basis pursuant to someone else’s formula. The best example of this is probably the “Wealthfront Equity Plan.” This solution proposes a fairly specific approach to granting and layering equity compensation. It sounds great and actually can work well for some companies. But, this approach does not scale well over time or company size. The use of equity over time is too high to be sustainable at many companies, especially in this age of Mega-Pre-IPO companies.

Idea 3: Creating a variable or liquid pool of grants where participants’ holdings may change up or down each year. A great example of this approach is in the book “Slicing Pie.” This is another idea that works in limited scale and with specific facts and circumstances, but quickly becomes unworkable in rapidly growing or VC-backed companies. There are also some serious communication hurdles with this type of program.

Idea 4: Granting new RSUs as if they were actually granted at values from days long gone by. This is a solution that is reportedly being done at Twitter. The company is apparently trying to make up for value lost on stock options granted in prior cycles. This is another innovative solution that requires some serious buy-in from the Board and possible investors. If the market bounces there is real risk of an individual essentially ending up with double-value equity. If the market doesn’t bounce, this could be a genius first strike.

Idea 5: Ceasing to grant equity and instead giving cash. Cash is great and nearly everyone loves it. But, cash is finite and nearly every company needs it when times are tough. If you are sitting on a horde of cash and believe that your company’s market and prospects have nowhere to head but up, this may be a solution for you. But, if you are a typical company, your sales pitch to the C-Suite is likely to make you look like a fool.

And a couple of classics…

Idea 6: Granting stock options that can be transferred to other individuals. This was a “trend” that was heavily promoted at the end of the 1990’s. It truly only benefited people who had gobs of money to spare, but the sales pitch was effective enough that at one point more than 25% of plans had this feature (it doesn’t even show up in survey data anymore.)

Idea 7: Providing a market for individual to sell their underwater stock options to a bank or other investor for a predetermined price. This was the “Microsoft Solution” in the early 2000s. JP Morgan agreed to purchase outstanding underwater stock options for a given time period. The company had to change the terms of the options purchased by the bank to allow them to be held by a non-employee and for a longer period of time. The value provided to optionees was nominal, but given the company's specific circumstances and budget to cover the administrative costs this solution was viable. You know who it wasn’t viable for? Nearly any other company ever. But, that didn't stop several banks from trying to sell this idea to many companies for years after the fact.

The important thing is knowing that another company's solution is very likely to be risky or worse for your company. This post is already far too long, so I will have to continue this series in my next post on March 28, 2016. Thanks for hanging in there through this complex topic and I hope that if you have questions you will feel confident enough to post them in the comments area.

Dan Walter, CECP, CEP is the President and CEO of Performensation. He is passionately committed to aligning pay with company strategy and culture and has been deeply involved in equity compensation for a long, long time. Dan has written several inustry respurces including, Performance-Based Equity Compensation and “Everything You Do in COMPENSATION IS COMMUNICATION”, with Comp Café writers, Ann Bares and Margaret O’Hanlon. He has co-authored “The Decision Makers Guide to Equity Compensation”and “Equity Alternatives” and a few books. Connect with Dan on LinkedIn. Or, follow him on Twitter at @Performensation and @SayOnPay.

“Employee-Friendly” Equity Compensation

What are current (2016) best practices for employee stock option programs for US pre-IPO startups?