Strategies to make the most of stock option plan

Updated: Nov 13 2012, 09:53am hrs
A stock option plan gives an employee a right to purchase the companys shares at some time in the future at a pre-determined price. Stock option plans have motivational and retention benefits. Here are five strategies that will ensure that your stock option plan turns out to be a blockbuster.

The success of any plan depends on its ability to convince its targeted participants. They should be able to perceive it as a chance to incentivise themselves for their performance, and not as a noose to tie them to the company.

The employees should be made to understand that the plan gives them the flexibility of participation as well as an opportunity to grow with the company. The employees should be made aware of the eligibility criteria to participate in the plan, its operation, benefits and associated tax implications. Most importantly, an employee must know how and when an employee can exit from the plan and encash the promised wealth.

In case the companys shares are not traded, determination of the fair market value of the shares could create uncertainties for the employees. The company could build the confidence of the employees by upfront providing the valuation methodology rather than leaving it to discretion of the promoters.

When it comes to stock option plans, employees struggle to understand the technicalities and the legalese of the plan. Hence, the company should ensure appropriate and clear communication by conducting group sessions for employees, by introduction of an FAQ manual and an executive summary of the plan.

An effective plan is one that has inbuilt alternatives for any situation; for instance, change in organisation structure, termination of employment, and underwater options (when exercise price is more than fair value of the shares). Besides, the plan should be so drafted that there is enough room for future amendments that are not detrimental to the interest of the employees.

A company can choose to self-administer the plan through a compensation committee or through its board of directors, if the employee population covered under the plan is not large. Otherwise, an employee welfare trust may be created for administration of the plan. The trust serves multiple purposes, providing easy administration and generating confidence among the employees by holding shares on behalf of the employees.

Last but not the least, the company must ensure that its plan complies with the relevant stock exchange guidelines, tax laws, corporate law, etc. The company should preferably take assistance of an expert who can ensure that all legal requirements are complied with.

Thus, the company that is able to harness the benefits of the stock option plan is the one that develops and promotes the plan using the right techniques. With a little planning, you can encourage your employees to generate billions for the company and the company can pay employees in millions.

The writer is senior tax professional, Ernst & Young. Views expressed are personal