Skype as been vilified for buying back shares from vested and exercised stock options (see details here and here). The acquisition of Skype by Microsoft increased the stock value enormously. Ex-employees complained that the company required the return of shares exercised, while only providing the original exercise cost as repayment. In the paradigm established during Equity Compensation’s Golden Decade (the late-1990’s), this type of provision was nearly unheard of. In the more than 10 years since the last big IPO boom, companies and investors have become more careful and plans more complex. Provisions covering change-in-control, terminations, performance criteria, clawbacks and more have evolved. Some features exist to protect investors in an attempt to avoid some of the perceived excesses from the last boom and crash.
Equity compensation is a unique tool. Plans can be designed with almost any combination of provisions. Grants at two companies, given exactly the same date, same price and same number of shares may have wildly different final values. Virtually all equity compensation is restricted by a time-based vesting schedule. As we move into the era of “Say on Pay” performance hurdles are also being added to these awards. The combination of complex terms, delayed payout and unpredictable value can make these programs difficult to design, communicate and administer. To get started you must first decide what it is you are giving to recipients.
Compensation: Accounting rules consider stock options, restricted stock, RSUs and related awards to be “compensation” from the date they are granted. The guesstimate aspect of ASC 718/FAS123R works well within the framework of accounting, since it provides a baseline to represent the fact that the company has given something of potential value. At the same time compensation professionals tend to want to more concrete values. In the eyes of the employee, compensation is generally viewed as a fair exchange of value for services rendered. When values change constantly, defining “fair” is a never-ending process.
Gift: Research shows that a majority of individuals view stock options as a “gift.” In other words they significantly discount the value of the grants and view them as something that is a “nice to have” instead of an essential element of their compensation plan. An interesting aspect of gifts is that most people don’t link effort to the payout. It is also considered very bad form in nearly any culture for a gift-giver to take a gift back. Imagine reaching over and taking back a present that you just gave someone for their birthday. Even if they didn’t want, or like, the gift, it becomes theirs to do with as they please. If equity compensation is truly a gift, then taking it back is simply poor etiquette.
Reward: In a pay-for-performance world, equity compensation is increasingly becoming a reward for achievement or success. Initial values mean far less than what is finally delivered (or not) to the employee. Performance criteria add another layer of complexity to a program. But, performance may also add the secret ingredient of direct alignment that allows for a cogent discussion and education on current and potential value. The key to any reward making sure the linkage between achievement and payout is reasonable and comprehensible.
Lease: Similar to the terms of a lease, “full value” awards like restricted stock, RSUs and phantom stock explicitly communicate that the underlying value does not belong to the individual until vesting occurs. A leased stock option is far less common. Companies often deliver equity compensation as a lease, when they want to ensure that employees stay involved until the job is done. Imagine you want a restaurant built. The contractor puts in the foundation and framework and then walks away telling you that another contractor can finish the job. Did the first contractor earn his compensation, if he did not finish his job? What if the restaurant became a huge success? Would the original contractor be entitled to any of the profit? The issue with leases is in communication. When everyone understands the terms, there is little argument at payout, or buy-back.
Defining and communicating the purpose of your equity compensation is the only way to ensure it has real value. There’s no explicitly right or wrong way to grant equity. Like the old west, its history is filled with tall tales, amazing gold rushes and expansive horizons. You can craft a program to meet your needs, with little regard for how others have traveled the same road. Regardless of whether you are compensating, rewarding, gifting or leasing, make sure that if you forge your own trail everyone understands where you are going, why you are going there and what will happen if they leave the path early.