Even some of the most successful companies had to deal with underwater options throughout their history. Although it’s unpleasant to see your company losing some of its value, you probably still have faith and believe things will get better. The challenge is, how to harness your employees to the same belief?
This article will give you all the practical solutions to keep them invested in the company regarding the stock options offered to them. Ready? Let's dive in.
*important note: there is a difference between handling underwater options in a private company to a public one. In most cases, the employee is well aware of the stock price of a public company but in a private one, the valuation might come only once in a while so the information might not be as available. This fact gives the founder a lot of responsibility towards his employees in a private company as he might be more aware of the company’s financial status.
The capillary waves
Just like a single water drop can send waves to alter the entire pool, a company’s drop in value will have a direct effect on its stock price and therefore the attractivity of the offered stock options. If for example, the exercise price for a stock option was granted at $10 and the stock is now estimated at $7, this so-called benefit is now not only worthless, it is actually more expensive for an employee to buy a stock than any other person. Underwater options are common but nonetheless problematic, as they demolish the employee's spirit and commitment to the company’s success.
Keep their head above water
Fortunately, there are several methods to take for keeping this grant-based compensation attractive and with it, ensuring the commitment of the employees. We organized the methods from the most used to the rarest, although picking the suitable one for your company is completely up to you.
Lower the current
This option is known as Repricing, it describes a change in the exercise price in each grant letter to fit the new common stock price. Repricing is a good fit for companies that believe the change in value will stay for a while, it’s not like giving up to the current state and more of a calculated next step for the near future.
Adjusting the exercise price is a good way to let your employees stay connected and give them an extra push to re-establish the company's formal value and to go further. Just keep in mind that repricing is a form of Modification and therefore should be addressed on the expansion report for the yearly financial report.
Repricing means to reopen every grant letter, change, and resign it so for larger companies this process might take a while. Remember, keeping track of these changes is crucial as well as updating all this information in your cap table, the old grant letters should be kept as well but with a noticeable remark that they are void.
Change the flow
Some funders prefer to make a change in the grant letter conditions as it sends the message that they believe the company’s value will rise, but nonetheless, the employees haven't gone unnoticed. A change in conditions can expedite the vesting period, redefine its vesting condition, or even increase the number of allocated options. These changes also go under modification and therefore affect the expensing report and should be addressed in it.
Similar to repricing, a change in grant conditions requires a rewriting and signing of every grant letter in the company. keep in mind that a change in the vesting condition, such as a move from a grant by performance to a grant by service, can have an impact on the employee spirit as each sends a different message. Make sure to openly explain the changes and how it is done to benefit the employee so nothing will not fall in the translation of the situation.
Can doing nothing be actually doing something? in this situation surprisingly yes. Well although some actions need to be taken, financially and stock options-wise, you don’t have to make any changes. Sometimes, a decrease in a company’s value can be short-termed or affected by an event that should end soon enough, therefore keeping everything as it is should be a valid option.
In this covid-19 couple of years, some startups might have suffered a significant downfall, they might believe this situation won’t last forever. An expected growth should start rebuilding as soon as things get back to normal. This example shows a good reason why some founders don’t want to make any changes and keep everything as it is, that being said one thing is crucial when making the decision to hold any changes - clarity.
Make sure to stay perfectly clear with your employees, explain the reason for the value dropdown and why you think it shouldn't impact in the long term. Here, keeping your employees in check is all about how often you speak to them and what you say exactly. As they don’t see any changes done to their benefits, they might get discouraged easily and should be given often pep talks and motivation starters.
Although used on rare occasions, it is possible to change the grant method from stock options to Restricted Stock Units (RSUs). Unlike stock options, RSUs come without any basic cost, so they are technically actual stocks to be issued in the future. This grant method negates any effect of the stock price and therefore helps encourage employees to invest in the company without any applications to their own money.
Offering RSUs is a big deal so make sure to carefully consider the meaning of letting employees enjoy free (+tax) stocks. As it might be a huge morale booster, this opportunity will let many people have partial ownership in the company, and in cases where there are many employees, it can delay the company's increase in value (as the options are given for “free”).
Underwater options accrue when a companies share value drops below the exercising price offered to employees in their grant letter. There are multiple ways to address the matter in order to keep the benefits and morale with your employees. Because each method might suit a variety of founders with different kinds of companies or situations, we suggest choosing a method that is aligned with your point of view, to give you a better good night-sleep and hand your subordinates a vision you can both share.
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