Lesson #219: Stock Option & Incentive Plans for Startups

I previously wrote about the importance of spreading equity to your employees or key partners. Stock options or other similar incentive plans are a great way to attract talent, incentivize employees and build long term employee loyalty for your business.

Some companies prefer to grant them only to senior management.  But, I am a fan of distributing them through the entire organization, so everyone feels invested in your success together.  Plan to set aside 10-20% of your equity value for your expanded team (e.g., 1-5% for senior execs; 0.5%-1% for middle managers; 0.25-0.5% for entry level staff). This is assuming they are normal salaried employees, and not a co-founder, where equity values could be materially higher (re-read this post on how to split equity between co-founders).

There are typically four types of incentive plans for you to consider, with various rules and tax consequences for the company and the recipients, as summarized below:

1. Non-Qualified Stock Option Plans (The Most Typically Used, Given Advantages Below)

Who Can Receive:  Anyone (e.g., employees, directors, partners)
Waiting Period to Exercise:  No restrictions.  Exercise anytime after they vest.
Exercise Price:  At any price, but taxable to recipient if less than fair market value (FMV)
Transfer Rights:  May or may not be transferable, depending on how you set up the plan.
Term of Options:  Exercisable anytime, provided plan is not set up otherwise.
Value of Underlying Stock:  No limit at time of exercise, provided plan is not set up otherwise.
Taxes to Company:  Deductions allowed from grants, at time recipient recognizes income, provided the company fulfills its withholding obligations.  This ordinary expense is equal to the ordinary income declared by the recipient.
Taxes to Recipient:  No tax at time of grant or exercise.  The recipient receives ordinary income at time of exercise for the difference between sale price and strike price. (So, people don't typically exercise until close to a known liquidity event where they will receive proceeds to cover taxes).

2. Qualified Incentive Stock Option Plans (Not Typically Used, Given Restrictions Below)

Who Can Receive:  Employees Only
Waiting Period to Exercise: One year.
Exercise Price:  At least equal to fair market value (or at least 110% of FMV for 10% holders)
Transfer Rights:  May not be transferred to anyone.
Term of Options:  Exercisable no more than 10 years after grant.
Value of Underlying Stock:  Cannot exceed $100,000 at time of exercise (in one calendar year).
Taxes to Company:  No deductions allowed from grants.
Taxes to Recipient:  No tax at time of grant or exercise.  Capital gain on sale of underlying stock (provided they hold the stock for at least one year after exercise, ordinary income if not).

3. Phantom Stock Option Plans

For some companies, the founders do not want any dilution to their equity.  But, they want to incentivize their employees with the same economic value they would have realized by owning equity.  In this scenario, you would launch what is known as a Phantom Stock Option Plan.  Instead of given rights to purchase stock, you are giving rights to receive the same economic value they would have made by owning the stock, without actually owning the stock.  These cash payouts are typically tied to a liquidity event or exit for the company. For tax purposes, phantom stock is treated the same as deferred cash compensation. Phantom stock payouts are taxable to the employee as ordinary income and tax deductible to the company.

4. Profit Sharing Plans

Another way to accomplish the same incentive, is to establish a profit sharing plan for the company.  So, instead of splitting up the equity and ownership of the business, you simply split up any profits that are generated each year.  The benefit to the individual is getting more control (easier to influence driving profits, than sale of company), in a more timely fashion (paid out annually, instead of at unknown time of sale of the company).  The problem with this route is early-stage businesses should not be distributing cash to its employees, it should be reinvesting that cash into accelerating the company's growth during its early-stage years.  So, if you plan on being a heavy cash user for growth, I would avoid this route.

Vesting, Acceleration & Other Key Terms

In all of the above cases, it is important you put a vesting schedule in place for the recipients before they are able to exercise their options.  Most vesting schedules are set over a four year period of time, to create long term hooks for retaining employees.  Typically, 25% vests per year, where it is a cliff vest in the first year (you have to wait all 12 months before first 25% is earned).  That ensures if an employee is not working out, you can terminate them without losing any equity.  Then after the first year, 1/36 of the 75% is earned monthly, over years two, three and four.  In the event there is a change in control of the business, you would typically accelerate the vesting to 100% earned, so the recipient can get the value created in the sale.

In addition, you want to make sure the company has a mechanic to buy back the underlying stock at the then fair market value and does not allow the recipients to transfer equity to other third parties outside of the company, without your written approval.  You typically don't want equity in the hands of strangers or "unfriendly" parties.

And, worth mentioning, you don't typically grant stock outright, as you do not want to trigger any immediate compensation tax consequences for the recipient or the company.  And, if you don't want to have the expense of setting up and maintaining a formal stock option plan, there are ways to motivate specific individuals, by granting them individual warrants to purchase stock, often with the same economics and vesting you would see with a stock option plan for many.

Hopefully, you found this high level education useful.  But, these are really complex issues.  So, as always, when setting up your plan, seek the counsel of a good startup lawyer to help you avoid the many known pitfalls (here is a good list of startup lawyers in Chicago).

For future posts, please follow me on Twitter at: @georgedeeb.

Lesson #218: You Don’t Know, What You Don’t Know

A person’s knowledge base is entirely dependent on their personal life experiences.  What did they study in school?  What did they learn in their jobs?  Who are they networked with?  What challenges have they had to solve?  etc.   In your business decision making, you are typically tapping into those past experiences to help guide you.  And, when you don’t know the answer to something you know you need, you are typically smart enough to do a little digging, ask the right questions and track it down.  But, there are two problems with this.

Firstly, notice I said “something you know you need”.  Unfortunately, in most scenarios, there is a wide range of other answers you need, but you just didn’t know it, because your life’s experiences haven’t yet brought them to your attention.  And, secondly, even if you asked the right, all-encompassing questions upfront, people are typically task-oriented, and once they have “checked the box” (in terms of answering those questions), they typically move on to the next task and never revisit those same questions down the road.  Which in today’s rapidly evolving world, can be a huge mistake.

The points here are, you are never stopping learning, and your quest for information should be part of your everyday process . . . not just checking off tasks from your list.  This includes revisiting key questions you have asked in your past, to see if anything is different, today, that can materially impact your business.  And, surrounding yourself by new people who may have something valuable to contribute to the discussion around your business.  This could simply be more networking in your local business community, or finding mentors for your business, preferably with people who have a far broader base of experience than your own.

Let me give a couple real life examples.  I was working with one client that was in the marketing technology space.  They had built a world class solution around one vertical of marketing several years earlier.  But, that was a different time, when enterprise brands were organizing their marketing departments around specific marketing verticals (e.g., digital, stores, catalog).  Today, only a few years later, those same companies are employing omni-channel marketing strategies, breaking down the marketing silos.  So, the company’s product today, although good for its vertical, needs to be completely rethought as it how it fits within designing an omni-channel marketing strategy, seamlessly sharing consumer data between the other verticals.

To further compound matters, this same client had built the core features of their business years earlier.  And, although they were cutting edge at the time, in a space with few competitors, today the market was ripe with new competitors that were nipping at their heels, with solutions that better than my client’s solutions and taking market share away.  The flaw in my client’s logic was the material investment in the product was behind them, and they could move those product investment budgets into other areas of the company.  When the reality is, product development is a never-ending process where the product needs to continue to innovate, each and every year, or it will die.

And, if that wasn’t enough, my client’s customers were shifting what they really wanted out of solutions in this marketing vertical.  It was less about the features and functionality, and more about helping their customers make better data-driven business decisions.  And, this client had nothing to offer its customers in this regard, and needed to quickly catch up.

So, for all you startup CEOs out there, your learning is never done, and your innovation is never over.  Surround yourself by smart people who know a lot more than you do, take off your historical blinders, replace them with a perpetual thirst for new knowledge and start with fresh thinking about your business each and every year.  The key word being THINKING, about what don’t you know about your business that you should.

For future posts, please follow me on Twitter:  @georgedeeb.

Lesson #217: Millennials Wreaking Havoc on Employers, or Vice Versa??!!

“Quick, help me, the inmates are running the asylum” is what is running through the heads of most business owners with multi-generational employees these days.  That is another way of saying those business owners are struggling with the rapid rise of the Millennials generation in the workforce, and how these younger employees are not behaving the way their predecessors have behaved, and it is creating a wake of chaos in the human resources department.   Let me explain further.

There has been plenty of research done and articles written on the Millennials generation (people born between 1982-2004, which includes employees aged 21-33 today) and their impact in the workforce (summarized in this article).   I never paid much attention to it, until one of my clients was experiencing the impact of the Millennials first hand, and I wanted to share those learnings with you.  And, since Millennials will make up 75% of the workforce by 2030, only 15 years from now, you need to incorporate such learnings into your employee recruiting and retention programs . . . and fast!! 

What Employers Are Seeing

·         Recruiting, Retention & Loyalty.  Many millennials do not see the need to stay at any one employer for more than a year, and worse yet they actually think it benefits their career to move from company to company.  This is the extreme opposite of the Baby Boomer generation, where workers could stay at one company for decades.  This is creating torture for recruiting.  Positions that used to be filled for an average of three years at a time, are now turning over annually, creating 3x as much work for the HR department.  And, companies are not hiring 3x the recruiters to keep up with that additional work, so recruiting is taking much longer, positions are not getting filled fast enough, and work productivity has slowed dramatically in recent years.

·         Changing Demands.  Many millennials are driven by: (i) a desire to have a big impact and “change the world” (so they want to work for companies that have a greater purpose than simply driving revenues); (ii) jobs that offer management responsibilities out of the gate (not simply being a cog in the wheel); (iii) managers that can relate to them as people, friends and equals (not a boss and subordinate relationship); and (iv) incentives that are material and more than simply cash (maybe including equity or other meaningful upside).

What Millennials Are Seeing

·         The Complete Opposite of their Parent’s Generation.   This includes: (i) many Millennials not being able to find jobs after college graduation, as the older generation of workers is not retiring as early, and not opening up jobs at the bottom end of the jobs funnel; and, hence, have many Millennials (ii) living with their parents longer, often into their 30’s; and (iii) saddled with tons of college debt costs and no way to pay them down.  Not a great position to be in.

·         Mismanaged Expectations.  Many Millennials have been raised as kids in a culture of “everyone wins a trophy”, regardless of your skills or performance (as early as the little league soccer fields).  And, they are not seeing that same treatment or experience as they enter their adult years, and it is a reality check right in the face.

So, My Recommendation to Millennials

Embrace the fact that you are a part of an economic society of workers, not the center of it.  Where your managers and peers may have years of learnings and experience to share with you.  Life is a two-way street, where give and take, and common courtesy (e.g., two week notice before departure, plan to stay at least a year), should be the norm.  Help educate your employers on what your desires and motivations are, so they can learn.  And, be sensitive to your employer’s needs, and the direct impact your actions have on compounding those painpoints.  And, for goodness sake, if you find a good company with a good manager, stick with them.  There is no rule you need to leave after a year.

And, My Recommendation to Employers

It is time to wake up and smell the coffee.  If you are waiting for the workplace to return back to the “good old days”, forget about it.  Figure out how to better mentor Millennials to your desired behaviors.  Or, better yet, take some mentorship from them, so you can better learn what they are looking for out of their employers, and give it to them.  Give them the challenging roles, with friendly managers and “change the world” goals they are looking for, and good things will happen to your company culture and employee retention in the process.

Millennials and employers need to learn to play nicer together in the same sandbox of employment.  Be sensitive to and respectful of the needs of the other party, and do your best to create an environment and actions that will be well-received by all involved.  Now, start with this “clean slate” fresh perspective, hug and make up and let’s start building something great together.

For all you startups out there, be sure to read my companion piece on how to build the right company culture, right from the start.  And, build your culture around the ever-changing needs of this newest generation of workers.

For future posts, please follow me on Twitter at: @georgedeeb.

Lesson #216: Provide Multiple “Wins” Throughout the Customer Lifecycle

If loyal, long-term customers are your goal, you need to romance them right from the start, and continue to wow them along the way with unexpected wins along the full customer lifecycle.  At the end of the day, the earlier you understand it is less about you and your business or success, and more about your customer and their business or success, the sooner you are on the way scalable long term growth.

When Pitching

You are setting a tone with your prospects from your initial pitch.  You cannot lead with every message about you or your company, and how great your product or service is.  Clients are busy, and want to get right to the point on how does this matter to my business.  How are you going to drive more revenues for me, or lower my costs or improve my customer experience?  How am I going to achieve an ROI on my investment with you?  And, more importantly, what’s in it for me personally?  How are you going to make me look smart to my boss?  Your entire pitch needs to lead with this “here is how the customer wins” mentality, where customer is defined as both the corporation and the individual contact.

When Selling

I almost didn’t use the word selling in this section.  Because nobody wants to be “sold” anything.  So, using the word “selling” loosely, what wins can you give your prospective customers through the sales process?  Did you just publish interesting market research for their industry that they can benefit from for free?  Did you get them a free ticket to the big industry trade show or other exclusive event, as your guest?  And, let’s not forget the individual contact.  Did you send flowers to them on their birthday?  Or, baby gifts when their kids were born?  Or, golfing at their favorite course?  Or, tickets to a sold out concert, as your guest?  This stuff matters in the relationship building with your customers.

When Negotiating

I previously wrote about the art of negotiation from your company’s perspective.  But, frankly, it is more important to master the art of negotiation from your customer’s perspective.  Everybody wants to feel like they “won” a negotiation, especially the finance or procurement departments of large enterprise clients whose sole job is to save the company money.  So, build that into your negotiation tactics.  Know procurement wants to “turn the screws”, and leave that cushion in your original proposals, so they can get their “win” and look smart to their bosses.

When Fulfilling

Making sure you deliver the experience they are expecting is the bare minimum, so they are not caught off guard by unexpected issues that could get them in trouble internally.  But, beyond that, what are you going to deliver them that they had no idea was coming?  What free upgrade to the higher version of your software?  Or, some free luggage to go with their vacation travel purchase?  Or, a free analysis of the data in the system they weren’t expecting?  You get the point.  It is all about creating “wow” factor.

The more pleasant surprises and customer wins you can bring you customers, the better will be their customer experience, the more likely they will be inclined to spread positive word of mouth and referrals, the easier it will be to get them as your brand ambassador reference, and most importantly, the easier it will be to get them renew their relationship with you over the years.  It is hard enough to acquire customers, so make sure you have your action plan in place to retain them.  And, customer wins along the way will help pave that road for you.

For future posts, please follow me on Twitter at: @georgedeeb.

Lesson #215: Stop Cherry Coating Your True Opinion

Too often in business, people want to be nice, avoid conflict or not upset their boss or co-workers by stating their true opinions.  All that does is create problems for all involved.  You get frustrated that the business is not going in the direction you think is most logical.  And, the listener is provided an opinion from you, which they think you are supportive of, that is potentially the wrong direction for the business and not truly what you feel is the right thing to do.  Hence, keeping the listener headed in the wrong direction.   In business, and particularly in startups where you cannot afford to waste time or resources heading down the wrong direction, there is only one mandate to live by:  always call it like you see it, regardless your role or title.

A CASE STUDY

I was recently at a client planning session.  Before the meeting, the COO and CFO were confiding in me that they felt the CEO was heading in the wrong direction, and they wanted the business to make a material pivot to keep the company from wasting any further resources going down a “snake hole”.  But, when the time came during the meeting for them to communicate that belief to their CEO, they refused to state that opinion.  And, worse yet, they succumbed to the “my way or the highway” personality of the CEO, and verbally told him they were in agreement with the CEO’s direction (despite their true feelings to the contrary).  In the meantime, the team is getting burned out and is losing confidence in their leader, and the CEO has no idea that employee dissatisfaction is monopolizing the talk around the water cooler, and has employees looking for the door.  What a mess!!

So, I have no problem stating my true opinion.  I decided I would raise the topic with the CEO, on behalf of the COO and CFO, but with the message coming from me, not them.  And, guess what?  The CEO didn’t lop off my head.  He listened thoughtfully, and it stimulated a healthy conversation on how best to fix the business.  Had I not been there to deliver the message, the business would still be staring over the edge of the abyss.  This is not about kudos to me for saving the day; this is about the lack of kudos to the COO and CFO  that lacked the strength of stating their true opinion to their CEO, regardless of not wanting to upset him or triggering off his explosive personality. 

GUIDANCE FOR MANAGERS

When you are managing a team of employees, you owe it to them to be honest with them.  If you don’t clearly communicate they are not doing a good job, they won’t know how to improve.  If you don’t clearly communicate you disagree with their ideas, you are losing out on an opportunity to help mentor them into your desired direction.

GUIDANCE FOR EMPLOYEES

On the flipside, as an employee, it is not healthy to think one thing and say or do another.  Your boss didn’t hire you to keep your good ideas to yourself, even if those ideas are in direct contradiction to the current beliefs of the team.  You can’t be so worried about upsetting your boss (or worse yet, losing your job), by putting your true opinion on the table.  The upside is, your good ideas will resonate and get adopted.  The worst case, they disagree with you and you move on.  And, if management continually shoots down your ideas, maybe that is a signal that is not the right company for you (or vice versa).

ALWAYS BE NICE ABOUT IT

Nowhere in this post am I recommending you be mean, rude or disrespectful when delivering your opinion.  All I am saying is, always say what you truly are thinking, for maximum satisfaction and optimal business results for all.

For future posts, please follow me on Twitter at: @georgedeeb.

The Best Medicine For Your Business? A Fresh Set of Eyes.

Over the years, I have had many clients with problems in their business that they didn’t know how to solve. They would invite me in to take a look to see if I could solve their problem. And, sure enough, a very easy solution to the problem presents itself in quick order. Not because I am smarter than them. But, because I came in with no pre-conceived ideas or past experience with the company, and simply came in with a fresh set of eyes and logical business sense.

Read the rest of this post in Forbes, which I guest authored this week.

For future posts, please follow me on Twitter at: @georgedeeb.