Employee Stock Options on the Precipice?

I am declaring February “Stock Option Month” at the Café (at least in relation to my posts). For more than 20 years I have been directly involved in the ebb and flow of employee stock options. When they are great, they are the best. When they are not great, they can be truly destructive. I will call it right now. We are, once again, on the precipice of the downfall of stock options. Consider the headlines below.

Stock Volatility has Shut Down the IPO Market: 2/1/2016, Quartz.com

Yahoo is letting employees cash out stock options sooner to stop the brain drain: 1/22/2016, Business Insider

The Truth About “Employee-Friendly” Financing Deals: 1/29/2016, The Information

Foursquare Lets Employees Swap Out Underwater Options: 1/19/2016, The Information

Square Adopts Worker-Friendly Stock Option Policy: 10/14/2015, BuzzFeed

Each article tells a story about employee stock options that are not working as planned or hoped. Every article explains alternative solutions. None, as of yet, announce the death of stock options, but if history is our teacher, the obituary is already written and waiting for a slow news day.

Here are some of the main issues:

1. Companies are staying private longer and with more value than ever before.

There are many companies who are private today that would have already had their IPOs years ago if the market worked the way it had for the past 15-20 years. Bigger companies equal more employees. More employees equal higher equity overhang. Higher equity overhang equals issues. This is especially true when there is little or no way to open up more space (typically accomplished at IPO by people exercising options and vesting in IPO trigger-based RSUs). In addition, companies are increasingly using more RSUs and less stock options.

2. Private company values as a whole are seeing a negative response to “unicorn” valuations.

Big, visible institutional investors have taken material write-downs on some of their “unicorn” investments. Valuations of privately-held companies are often based as much on confidence as they are fundamentals. When big companies are called into question, mid-sized companies are often hardest hit. This is true for both public and private markets.

3. Equity compensation data is less reliable than it has been in decades.

Survey data, in relation to equity compensation, is sort of all over the place. Virtually none of the data includes the details that are required to truly compare equity from one company, or grant date, to another (stock price history and expectations, terms of awards, etc.). Virtually all of the data is as volatile as the underlying markets. This makes it very hard to know that your company is truly doing the right thing.

4. Early moves from stock options to RSUs leave little room to maneuver.

15-20 years ago, companies simply repriced stock options to give employees a better deal. 5-10 years ago companies exchanged underwater stock options for full-value RSUs to provide value for their employees. Repricings are basically dead. Replacing bad options with RSUs is a tough sell when a company has already been granting RSUs. Changing option terms has been one new and popular move, but it requires a level of communication achieved by few companies.

5. The public market has been less than enthusiastic about many IPO companies after the deal is done.

There were no IPOs in January 2016. It’s the first time that this has happened in more than 5 years. Companies that have gone public have seen less meteoric rises in their value. Many marquee IPOs over the past 3 years are seeing flat or decreasing stock prices. Limited IPOs means limited liquidity. Flat or declining IPOs means little room to grant new options as burn rates become a concern.

So what should you do? Should you jump into the pool early and take advantage of positive (or negative) press and attention? Should you wait until there are enough others in the pool so no one notices that your body is not really “swim-ready”? Should you stay the course and hope that you can avoid the pool altogether? Is there another philosophy to consider?

There are potential risks and rewards in each of these strategies. Luckily this is an ongoing blog and we can explore some of these alternatives, and others, over the next several weeks (or more). If you have opinions on this issue, please share them in the comments section.

Dan Walter, CECP, CEP is the President and CEO of Performensation. He is passionately committed to aligning pay with company strategy and culture. Dan recently wrote a detailed isse brief on, Performance-Based Equity Compensation. Dan also cowrote “Everything You Do in COMPENSATION IS COMMUNICATION”, with Comp Café writers, Ann Bares and Margaret O’Hanlon. And believe it or not, he has co-authored “The Decision Makers Guide to Equity Compensation”and “Equity Alternatives.” Connect with Dan on LinkedIn. Or, follow him on Twitter at @Performensation and @SayOnPay.