Stock options are an important component of employee compensation in some companies, and the careful and thoughtful design and implementation of the plan itself is often the difference between a system that simply provides cash rewards for employees and one that significantly enhances corporate performance through increased productivity, improved employee recruitment, and decreased employee turnover.

The original concept behind offering stock options was to encourage a sense of employee ownership in the company. In order to make sure employees do not simply take the money and run, the plan's design and implementation must be carefully considered. The way the plan is communicated executed as well as the actual terms and conditions of the plan will influence the plan's success and effectiveness.

When you are designing your stock option plan, consider the following:

Who is eligible?
Decide who in the company is eligible for the stock option plan and at what time eligibility occurs. Broad based plans are designed to reach a large number of employees at all levels of a company and are the type that contribute most to overall performance approval. These plans tie overall employee performance to compensation rather than limit the benefit of improved corporate performance to key executives. Eligibility typically begins after a pre-determined period, similar to any of the benefits programs offered by the company.

Number of Shares Available
There has to be a cap on the number of share options issued under the plan. While plans vary, setting aside 20% of overall stock, not including start-up investment, is common. When you are ready to start allocating stock options, remember not to issue all of your stock options issued at the beginning of the program. You'll limit your ability to bring in new employees or expand the program if you don't hold stock options in reserve.

Exercise and Vesting Terms
When granting stock options it is important to determine how the exercise price will be determined. The simplest and fairest method is to use the fair market value of the stock at the time the option is granted. Valuation experts can help you determine the value of your company.

The other primary consideration is how the options will vest. Vesting refers to the time period that must pass before the employee is entitled to the stock options. The vesting period can be as long as seven years.

In some stock option plans, employees vest in some stock options each year. For instance, you can set up a stock option plan with a 5 year vesting period where everyone vests 20 percent each year. Some stock option plans use cliff vesting so that all options vest at the end of the vesting period.

Exercise Options
Regardless of the vesting period, stock options expire after a set amount of time, often as long as 10 years. There are many different ways for employees to exercise some or all of their share options. The most straightforward approach is for the employee to buy the stock and pay the company. The employee is then free to do with the stock what he or she decides. Some companies allow “cashless” transactions where the company buys back the stock the same day it is exercised. This leaves the employee with the cash difference.

When designing a stock option plan it is important to consider the overarching goal of the program. The specific terms and conditions must be coordinated in such a way that the company reaps the benefit as much as the employees.

Implemented and designed correctly, stock option plans can make a significant contribution to operational performance and should be considered as a valuable addition to the overall employee recruitment and retention efforts.

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