Stock Options for Employees: How Much to Allocate? (2024)

Are you looking to incentivize your employees and contractors with equity in your company? An Employee Stock Option Plan(ESOP)may be the perfect solution for you. By offering a slice of ownership in your company, you can attract, retain, and motivate your team to work towards your company's goals.

Stock option plans help you attract people with an ownership mindset. They, they want skin in the game and to be able to earn an outsized return.So if the company's successful, they're also successful. Say, right in the beginning, your company can be worth five 10 million but down the track it can be worth 500 million or more. And so employees that come in early and do the heavy lifting can benefit tremendously from these plans.
^{— JasonAtkins, President &Co-founder at Cake Equity}

Jason adds that incentivizing employees with stock options can result to more productive teams:

If you've got a nice ownership culture and you talk regularly about the value of options and, and what it does and, and how it's increasing over time, some really nice productivity opportunities for you there.

Which brings us to the topic of stock option allocation. Determining startup equity distribution can be tricky. It's important to consider your staff and future plans for your company, while keeping team incentivization top-of-mind.

How much equity should you offer?

The answer depends on your company's unique situation and future plans. You'll need to take into account the size of your option pool, the valuation of your options, and the role and time spent by each team member.

Size of the option pool

A good starting point when thinking about option allocations, is to consider the total sizeof the option pool.

A typical employee stock option pool at pre-seed round is about 12-15%, diluted to 10% at series A. Michael Houck adds that the employee option pool at Launch House sits at 10%.

"We have an employee option pool as part of our equity structure. It's 10%, which we recommend to be pretty standard. And every time we raise capital, we replish that to bring it back up to 10% available."
^{— Michael Houck, Co-founder at LaunchCapital}

For example, if the company has an allowance for a 10% option pool, and it wants to offer Options to at least 20 team members over the next couple of years, it clearly needs to take this into account in making the allocations.

Valuation of options

It can be useful to work out the value of options by considering how much they’d be worth if they were offered as stocks as part of the most recent capital raising round. This is especially useful where the options are being offered as a remuneration package top-up, as the company can clearly communicate how they decided how many Options would be offered, based on the most recent valuation of the company.

Role and time

While option allocations will sometimes vary between roles, it’s more common for them to be based on time spent in the company. For example, the early employees will have higher allocations, and the later employee allocations will be smaller, despite them being in similar roles.

Although this isn’t to say late joiners can’t get higher allocations – it all comes down to the specific values of the team member and company goals.

Calculating stock option percentages

It’s quite rare for an employee or contractor to receive more than 1% fully diluted ownership in a company, except where that team member is a senior hire, or the options are in substitution for a significant salary package.

Cake's equity benchmarking calculator allows you to make informed decisions on how much equity to give your employees. Using various datapoints from our own user data, specifically:seniority, role, and stage of growth, Cake does the math so you don't have to.

Keep in mind that where the recipient is an employee, they must be paid at least the minimum salary under the employment laws relevant to your jurisdiction and this salary cannot be substituted with options in most jurisdictions.

How do you value your company for a stock option plan?

Valuing your company for an ESOP involves determining how much equity to give to each participant and setting the exercise price in compliance with any tax rules.

Wherever you are in the world, your jurisdiction may have specific valuation requirements for setting the exercise price for an ESOP. For example, in the US, you need to secure a 409A Valuation before you can offer stock options to US-based employees.

Further, it is important that you ensure you use the correct method of valuation to access any available tax benefits.For example, in Australia, you can access the start-up tax concession. In the US, there are tax exemptions like Rule 701.