Exercise Your Options Offering stock options could help you nab the most desirable employees.

When is a whole pie worth less than a piece? If your business isthat pie and you're holding all of it, you may be hindering thecompany's growth, making it worth less than it could be.That's because a huge trend today--in companies as diverse butas successful as Microsoft and Starbucks--is the distribution ofslices of the business to employees. "There are plenty ofstrong reasons to give employees an equity stake," says DavidLewin, a professor at the University of California, LosAngeles' Anderson Graduate School of Management. "Everyemployee should have some compensation at risk. They'll sharein the downside and in the upside."

This thinking is big news for small companies. Until just a fewyears ago, only the senior-most executives in the majority ofcompanies were offered equity stakes. What changed all that?Entrepreneurial businesses, mainly in high-tech industries, beganmaking stock options available to all levels of staff. Suddenly,stories of Silicon Valley office managers worth several milliondollars began to emerge--and that turned options into a verypowerful human resources tool. The payoffs have been obvious, withmany companies that are most generous in options awards--notablyMicrosoft--emerging as growth pace-setters.

Robert McGarvey writes on business, psychology and managementtopics for several national publications. To reach him online withyour questions or ideas, e-mail rjmcgarvey@aol.com

Benefiting From Options

Just what can stock options do for you? Plenty--in recruiting,employee retention and employee motivation. But first, you need tounderstand the basics; namely, options are not stocks but ratherthe right to purchase stocks at a specified price, usually at adate well into the future.

Why not just give stocks to employees? Stocks have a superficialsimplicity in their favor, but look deeper, and the arguments areall in favor of options. For starters, options have minimal tax andaccounting impacts, at least until the options are exercised. Taximplications of stock grants are far bigger, and the impact isimmediate.

"There are so many ways awards of stocks can go wrong foryou and your business," says Wilton Sogg, an attorney withHahn Loeser & Parks in Cleveland.

Sogg points out there are many "what-ifs" to considerbefore awarding stocks: What if the employee quits? Gets fired?Becomes disabled? In any of these cases, you'd want a legallyvalid buy-back agreement prepared well in advance (ideally intandem with handing over the stock certificates). But buy-backs canstill go awry. What if you lack the cash when you need it? What ifthe employee's lawyer finds a loophole in your buy-backagreement? A disgruntled minority shareholder is always bad news;give out equity, and you may be preparing the way to give yourselfexactly that. Says Sogg, "There are many better, smarter waysto give employees incentives."

At the head of that list of smarter ways is options. First off,options can come with many attached strings, a common one beingthat they can't be redeemed until a specific date. "Fouryears is a common vesting period," says Marlee Myers, anattorney and managing partner in the Pittsburgh office of law firmMorgan, Lewis & Bockius LLP. But a vesting period of anywherefrom three to six years is normal, she adds.

Attaching a multiyear vesting period to options helps retainemployees, says David Morse, a partner in the law firm of Whitman,Breed, Abbott & Morgan in New York City. "If the employeeleaves before the options vest, they lose the options," Morsesays. "They have to stick around to get the pay-out.That's a big plus because hiring and training new employees isso expensive."

Hiring better people is another key benefit for companies thatuse options wisely. "By offering equity, [companies] giveemployees a chance to make big profits later," says Myers.Many job candidates will jump at this deal. And that means a lean,cash-strapped business can often hire employees at lower pay. Notall job candidates will find this prospect appealing--but thehigh-energy self-starters you most covet likely will.

Once employees are on board, options can jump-start theircommitment. A few stock grants won't mean an employee willsuddenly share your appetite for 80-hour work weeks--but optionswill likely prompt the employee to invest discretionary energy andcreativity into his or her job. "Options can definitely makeemployees more motivated," agrees Morse.

That said, don't take your employees' enthusiasm foroptions for granted. "You have to market the value of thisprogram to them," says Morse. You need to spell out toemployees that every stock option makes them a partial owner.

The Flip Side

Aren't there drawbacks to options? You bet. Plans can easilyrun afoul of securities and tax laws as well as accounting rules."You can make a lot of big, expensive mistakes," saysMyers. "Before setting up an options plan, get legal andaccounting advice."

The bigger worry, though, is dilution of shareholder value. Handout too many options that get converted into stock, and suddenlyper-share earnings can tumble dramatically. "This becomes anissue when you're looking for bank financing or are wanting todo an initial public offering," says Morse. "The moreoptions outstanding, the weaker your position."

Is that enough of a worry to put the brakes on an optionsprogram? Not judging by their mounting popularity. "Morebusinesses are looking into doing this than ever before," saysMorse.

"[In addition,] under the law, you can be very selectiveabout when and to whom you give options," says Myers. Wheremight you put options to best use? Nowadays the three chief usesare in employee recruiting, where hefty options awards are dangledbefore job candidates; as bonuses for key employees who help thebusiness hit certain tangible targets (sales or profit goals, forinstance); and, lastly, as across-the-board awards to all employeesto help keep them motivated. What formula will work for you? Thereis no generic recipe. But good advice is to start small--award tinyparcels of options and watch for the results. Odds are, you'llsee real improvements quickly, and you'll also discover thebest way to use options in your company.

In most cases, too, employees become more valuable in tandemwith their ownership stake. "The bottom line," saysMorse, "is that options turn employees into owners--and ownersdo act differently."

Contact Sources

David Morse, c/o Whitman, Breed, Abbott & Morgan,fax: (212) 351-3131; (212) 351-3131

Marlee Myers, c/o Morgan, Lewis & Bockius LLP, 32ndFl., Oxford Ctr., Pittsburgh, PA 15219, myer3310@ mlb.com

Wilton Sogg, c/o Hahn Loeser & Parks, 3300 BP AmericaBldg., Cleveland, OH 44114, (216) 621-0150.