Employee Equity Systems Are Fundamentally Broken
Updated: Feb 15, 2022
Most employees want stock options. In and out of the tech world, stock is an essential part of an employee’s overall compensation plan. It’s seen as valuable by employees and their families, and indeed, it can be. However, most employees don’t realize that stock options are fundamentally flawed and that there are other choices besides traditional stock options. Stock options can expose hard-working employees to liability and expenses they don't see coming.
What is broken?
Most equity systems are far too complicated for an average worker to understand on their own. When an employee is given their stock options paperwork, it is a complex legal document that, ideally, they would have an attorney review before signing. Hiring a lawyer is expensive, and they might not even know what kind of attorney to choose.
If they turn to their founder or CEO for clarification, they still can’t get answers.Founders and CEOs are not even allowed to help due to conflicts of interest, and they certainly can’t advise employees on the tax implications since they are not a tax professional.
Most workers believe that with stock options, they are being given stock as a form of payment. They imagine they are going to have stock in the company. In reality, they are being given a chance to invest at a specific price, for a certain number of shares. Usually, this realization doesn’t hit until they are vested or have terminated employment, and are told they have a short time to pay cash for all the shares they thought they owned outright.
When workers are departing, whether on their own or because they’re being let go, they are usually told that they have 90 days to buy the options or their stock vaporizes. Understanding leads to massive problems down the road.
One of the other key problems with stock options is their hefty tax bill. The IRS, rightfully so, says that if you’re getting something of value, then you’re taxed on that value. The problem is, this taxation occurs before the stock is able to be sold or transferred.
Even if the employee does pay the taxes on it, what then? What happens if the company goes belly up? Or what happens if the stock loses value? That employee has paid tax anyway.
These are critical matters for employee experience. These unhappy surprises and lack of transparent information about stock options serve to drive a wedge of mistrust between the worker and the company. This decrease in trust affects worker productivity and decreases the alignment in the organization.
There is no malicious party here. Most founders don’t know the implications of selecting stock options as their employee equity vehicle. They tend to be focused on building a company and being the best at what they do. They value their workers, and they want to share company ownership with them.
If a founder asks a lawyer about creating a stock plan, it can quickly end up with $20,000 spent and a stack of documents an inch thick that no one- in many cases not even the founder and certainly not the worker- understands. On top of that expense, the company now needs a yearly 409A valuation, and with every hire, the cap table has to be adjusted. The legal costs keep skyrocketing.
What makes a good employee equity system?
To solve these problems, there are two critical ways to evaluate an employee equity system.
Is it Fair to Everyone?
The equity system needs to treat people fairly. Does it put workers at a disadvantage and give founders and venture capitalists great equity plans? Is it fair to a founder to take on a significant financial burden in potentially unnecessary legal fees? In addition to the actual hard realities of the equity system itself, is perception. Do employees see the stock plan as being easy to understand? Does it motivate them and align them with the company’s goals?
Workers need to see that they can work hard to contribute value to the company and get a fair slice of the pie if the company is successful.
Is it affordable?
Given that the legal fees for traditional stock options can be so significant that they place a financial burden on a company at a time when they can least afford it, it makes sense to put efforts into reducing this burden.
With legal startup fees for stock options surging $20,000+ above other equity types such as Restricted Stock Units (RSUs), for a lower quality stock type, founders must manage the costs of the equity plan that they select.
Do workers believe it’s trustworthy and motivating?
Everyone in the company needs to feel that the equity system is trustworthy. It also needs to be motivating. Making it visual, bringing it to life by tying equity to value creation rather than just time at the company, can change static stock options into a living, motivating force for all workers.
The Truth Is….
There are better equity systems than stock options out there, but most businesses either can’t afford them, or their founders don’t know where to look for other options. The truth is, Fortune 1000’s have already cracked this code in innovating and using better equity structures to reward their executives. They are called RSUs, or Restricted Stock Units.
Choosing an employee equity plan is a critical part of aligning worker interests with the companies. Choosing one that is affordable, fair, and motivating will set a new company on a path with less friction and more time and money spent where it should be- building a great business.
Upstock combines performance equity, and a visual dashboard to make teams more aligned. With UpStock’s dashboards, you can easily visualize how your equity grows in real-time and know that your efforts count. There are no initial legal costs for the business owner or team members, and you are given a full set of legal documents created by the best legal minds in the world. To learn more, visit upstock.io or contact our team.