Should You Give Your Employees Stock Options?

By April Maguire

4 min read

While most employees wouldn’t agree to work without a weekly salary, wages aren’t the only form of compensation offered in the modern workforce. On the contrary, many businesses offer their workers employee stock options (ESOs). ESOs are stock options granted only to company workers that give employees the right—but not the obligation—to buy a set number of shares at a prearranged rate. Workers can then sell the shares at a later date based on the terms of the option agreement.

While giving employees stock options offers a number of benefits for both businesses and their staffs, the practice is not without its drawbacks. Before offering stock options, companies should take the time to consider all the pros and cons and make the best decision for their business.

ESO Pros

Here are some of the benefits associated with giving your employees stock options.

Price

One of the advantages of rewarding employees with stock options is that a company can save money on salaries and bonuses. It’s no secret that the cost associated with benefits like health insurance has skyrocketed in recent years. With stock options, a company can offer incentives to its workers while saving cash from month to month. The only expenses to the company are the costs associated with administering the program and selling the stocks.

Motivation

Another benefit of offering employee stock options is a rise in worker motivation and loyalty. According to a recent article, 88% of employees lack a sense of passion for their work. Not only are unsatisfied team members more likely to slack off on the job, but they may also be more willing to abandon your company for a competitor.

By offering ESOs, companies can generate a greater sense of investment among their workforce and enjoy increased productivity as a result. In the long run, allowing workers to share in the profits can help a company perform at a higher level.

Recruitment and Retention

As the job market improves for workers, employers have to work harder to hold on to the most qualified staff. Not only does offering stocks keep current workers motivated, but it can also help ensure that your best people don’t leave you for the competition.

With employee turnover costing 1.5 to 2 times the price of the worker’s salary, it’s clearly in a company’s best interest to hold on to its top people. And who knows? Offering a solid employee stock program may even enable you to draw some of your competitors’ superstars into the fold.

Cons

Below are some of the drawbacks associated with offering stock options to employees.

Decline in Motivation

When your company is doing well, it’s only natural that offering stock options to employees would serve as an excellent morale boost. Unfortunately, the flip side is that when company performance lags, worker motivation may soon follow suit.

Because employee performance is tied to company success, employees may begin to feel frustrated or even angry as your business stock loses its value. If ESOs are taking the place of cash bonuses or other benefits, employees may begin to resent the business as stock values plummet as well. In the long term, worker motivation may drop off, leading to an overall fall in productivity.

Additionally, employees may become frustrated by the unexpected tax burdens associated with ESOs. In some cases, the option agreement puts restrictions on shares or prevents workers from selling them immediately. If employees aren’t anticipating the tax burden, they may begin to resent the company.

Furthermore, they may not realize that profits on sold ESO shares are considered compensation and, hence, taxed in the same way that income is. If workers neglect to pay their taxes, they may wind up facing hefty penalties. In some cases, employees can even insist that the business repurchase the stocks. The result is a decrease in company cash flow and an unsatisfied, unproductive workforce.

Company Taxation Issues

Unfortunately, tax issues don’t just affect employees who purchase stock options, but also affect the companies that sell them. When a company offers discounted stock options to its employees, the government often views them as a form of deferred compensation. As a result, the company may wind up facing significant taxes in following months.

In some cases, businesses can offer incentive stock options (ISOs). Although ISOs tend to have more restrictions on sales, they offer a number of tax advantages over non-ISOs. Because they are taxed at the capital gains rate instead of as regular income, ISOs may benefit both employees and employers come tax season.

Offering stock options to employees can help companies align the incentives between a company and its employees. Businesses should be conscious, however, of all the drawbacks associated with this practice. Doing this helps companies make more informed decisions about their finances and avoid potential problems down the line.

If your company is having issues with employee retention, ESOs may not be the only way to help. Here’s how to identify and improve your company’s culture and, in turn, retain employees.

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Information may be abridged and therefore incomplete. This document/information does not constitute, and should not be considered a substitute for, legal or financial advice. Each financial situation is different, the advice provided is intended to be general. Please contact your financial or legal advisors for information specific to your situation.

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