How to determine how many stock options to grant?

 Hi Bill,

This is a very interesting question. Many companies simply grant the options without serious thought about the how much to issue. A few companies try to be more scientific, and I am happy to see that you are going to this extent. When granting simple employee stock options like yours, we take the following steps:

(1) Determine the "Financial" bonus that each employee should be receiving; this is a does exactly the same way you would determine the cash bonus that the employee would get, for example, $10,000 for John Smith.

(2) Run the valuation model (we are using the Black-Scholes model) for the options based on the optoin parameters as of the current market price, for example, $5.5 per option.

(3) Determine the number of options that John Smith will be receiving based on this valuation, for example, $10,000 / $5.5 = 1,818.

(4) Round up to the closes 1,000, that is, 2,000 options.

(5) Present the proposal to the board of directors to get their approval. The proposal would include the overall financial impact of this grant on a quarterly basis. We use OPTRACK (http://www.optrack.com) to simulate the issuance and prepare the proposal for the board of directors.

(6) Communicate via a grant letter to the board of directors.

(7) Create the grants and generate the grant letters to give to the employees.

Using this method usually helps in ensuring that the employee appreciates the value of the options they are receiving.

If you have further questions or comments, please contribute to this thread or contact me at ramy@optrack.net or 41.6258.1376.

Thanks.

Ramy.

Bill --

Ramy's advice is excellent. Here is what we normally recommend for broad-based plans:
1. Don't set aside X% of shares to grant, do it once and maybe some time in the future, and let it go at that. X% of one company is not worth anything like x% of some other, yet this is a very common metric companies use. They often end up saying 10% and give most of it out early on, not leaving enough for growth.

 
2. Instead, set a critical number target for the year -- it might be profits, growth, EVA, or something else. If you meet this target, create an equity pool based on what achieving this target would be expected to do you tour stock price or some other metric. If hitting a profit goal would, other things being equal, increase you share value by $100,000, for instance, you might decide that 25% is a reasonable number. The benefit of this is that the awards are not entitlements, but something people achieve. You can track these numbers during the year, and that in itself is motivating. Do this every year.

 
3. Divide the pool among groups based on their relative contribution to the company (that may measured by salary, but you may want to add some other factor or factors as well). Then, as Ramy says, see if this number is enough of a bonus to get people's attention and seem fair to everyone.

 
4. Explain the formula to people often, follow the numbers regularly, teach people to understand and use the numbers, and adjust annually as needed. A lot of what makes ownership plans work is not the money, but the culture. We have definitively found that companies that combine open-book management and high-involvement management (teams, etc.) with broad-based ownership (only broad-based works) significantly outperform expectations.

 
More details on this can be found in our book The Decision Makers Guide to Equity Compensation. For details, go the Web site f the National Center for Employee Ownership at www.nceo.org.

 
Corey Rosen, National Center for Employee Ownership

Another important consideration is the pool of authorized shares that may be awarded under your equity plan.  The shareholders should have approved the plan stating the maximum number of shares that may be awarded as options.  Your decision on the number of options to issue should take into account the dilution arising from the grants, and the annual "burn rate" - dilution arising each year from your awards.  This is taken into account in the ISS analysis of your executive compensation program.

Linda Wilkins

Wilkins Finston Law Group LLP

www.wifilawgroup.com

I wanted to past an answer here to look smart, but the answers from Corey, Ramy and Linda are a great foundation.  Anything beyond that would likely require some in depth discussions on WHY you are granting equity and what you expect participants and the company to get from the grants.

Happy to have that conversation if you are interested.

Dan Walter

Performensation

dwalter@performensation.com

415-625-3406