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Stock option plans: What employers should know

Employee stock options have become increasingly popular in recent years. Due in part to the rise of small- and medium-sized startups, stock options are being included in employment contracts more and more frequently. For employees, stock option plans offer a share of their employer's success; for employers, stock option plans attract and retain talent without draining the company's pocketbook.

Stock option plans: The pros and cons

  • Pros

1. Stock options are often very appealing to would-be employees. Owning stock options means that if a business takes off, the employee will reap the very lucrative benefits. Take Facebook: When the company's success skyrocketed, many of its employee stockholders became rich.

2. For cash-strapped startups, stock option plans are an employee benefit that does not require the company to shill out a lot of cash. Stock options can help small companies compete with large companies in terms of employee benefits.

3. Because employees pay the exercise price for their stock options, the plans can actually help contribute much-needed capital to the company.

  • Cons

1. Companies face the risk of shareholder equity being diluted when employees exercise their stock options.

2. The lack of liquidity in stock options makes some employees leery. After all, most private companies will not ever go public--meaning most options will not be equal to cash benefits. Many people prefer other incentives like cash bonuses or higher pay.

3. If a company does not eventually become more valuable, its stock could very well be worthless. For every instance of a loyal employee becoming a millionaire through stock options, there are thousands who will not.

Stock options and employment contracts

Stock option plans are generally written into a company's employment contracts. Each plan may vary depending on the employee's title, job duties and salary. When employers and their attorneys are drafting this part of the contract, it is important to address issues like total number of shares, number of options, plan administration and shareholder approval.

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