US Corporate Law 20 Episodes (3)

How big should the option pool be? How many options are given to employees at different levels? The difference between restricted stock and options | Don't think that setting up option pool options is a matter of one sentence | The difference between option pools of Chinese and American companies.

In the first two issues, we talked about the issue of founder equity distribution. In this issue, we will talk about employee option incentives.

When it comes to options, we must first clarify a few confusing concepts.

1. Employee options and options in financial derivatives

The first confusing concept is options in financial derivatives. People in finance often say stock option, and startup companies often say stock option. In fact, strictly according to the U.S. securities law, the employee's option is called the compensation stock option. The compensation in this place is similar to the compensation written in the labor contract when we worked in the U.S. company. a reward.

Going back to the source, employee options should be a special manifestation of options on financial derivatives. Options for financial derivatives are divided into call options and put options. Employee options are all calls, not puts. This means that when employees buy options, they expect the company to develop in the future. You can cash in these options to buy the company's stock, instead of shorting the company in the hope that the company will fail.

On the other hand, the difference between employee options and options in financial derivatives is that the options in financial derivatives will have a bid price, which is very low relative to the exercise price of the stock, such as 100 yuan for a stock. The purchase price is 10 yuan, then if the actual value of the stock does not reach the height you expected later, you will not exercise the right, which is equivalent to the 10 yuan wasted. The employee option is a kind of remuneration for employees to work in the company, so this purchase price is equivalent to a part of your salary, and employees do not need to pay this additional purchase price.

2. Restricted equity vs options

Another concept that is easily confused by everyone is restricted equity. Restricted stock is restricted stock, and options are stock options. Restricted equity is actually a kind of equity, shares, stocks, and it is a real power. The option is a kind of "right to expect shares", so it is not an actual share, and the option issued does not account for the proportion of the company's voting rights before you actually exercise the option.

So the reason why many people confuse these two concepts is because they both have a four-year period, which we will talk about in the next issue. How these four years work. But the four years mentioned in the restricted stock rights are the four years when the company that issued you the stock gradually loses the right to repurchase your stock. In between, the company has the right to buy these shares back. Note that this place is bought back at market value, not for nothing. The four years in the employee options are the four years in which the employees gradually get the options, which means that the employees have nothing in their hands at the beginning, and the company gives the employees little by little during the four years.

It can be seen from this that restricted equity is obviously much better than options. So this also leads to the fact that restricted stock is often given to founders, and options are often given to employees.

3. Don’t think that setting up an option pool option is a matter of one sentence

A common misunderstanding is that many entrepreneurs think that setting up an option pool is a matter of one sentence. We often see some founders discussing how many shares you have, how many shares I have, and how many shares are reserved for employees when the company is first established. Then I started to download a template from the Internet to issue option contracts to employees. Later, when investors want to come in and do due diligence, the entrepreneur contacts a lawyer. I got all the company's documents and saw that the options for hundreds of thousands of shares have been issued. The option pool has not yet been established, and the options issued earlier are invalid.

Because most startups are registered in Delaware, let's take Delaware as an example. In fact, most states in the United States have the same regulations. The company has certain matters that must be voted on by shareholders to be validly passed:

Amendment of company registration certificate

Sell ​​a substantial amount of equity or assets in the company (this is generally referred to as equity mergers or asset mergers)

Election of board members

Create an option pool

Interested Director Transactions

Several other items will be mentioned in our later programs. Today, we will say that this option pool must be approved by the shareholders' meeting, and the sale of employee options can only be completed with a set of documents, not like a registered company. , be sure to ask a legal professional before establishing an option pool and selling options.

4. How big should the option pool be? How much options are given to employees at different levels

The option pool is not as big as it wants to be. Generally speaking, the ratio is 5-20% in the general market. The option pool that is more suitable for the initial stage of start-ups is generally a ratio of 10%-15%. It is not recommended that you set an option pool that is too high or lower than this ratio. Because if it is too high or too low, when you look for investors later, investors may have more concerns, and you have to spend a lot of time explaining to investors why you want to design such an option pool that does not conform to the market status quo. Entrepreneurs should still spend more time introducing their projects rather than option pools.

Then after the total number is determined, let’s look at the proportion of employees in each position. Here we take the company at the stage of the A round as an example, because it is certain that the equity will become more and more diluted in the future. Here is an approximate range for your reference:

(1). General CEO CEO other is 5-10%. Some people will say that the CEO of a startup company is not the founder himself? The founder already has equity, can he still get options? The answer is yes. The founders, CEOs and CTOs of many companies also take options. Of course, there are some founders and CEOs of startups who, in order to encourage their employees more, choose not to take options. Both are feasible.

(2). Then there are CTO and COO, technical director and operation director, generally 2%-5%. Still like the example of the CEO above, whether the CTO and COO are founders does not directly affect the issue of whether they can take options.

(3). Then there is the VP level, which is 1-2%. In general, most of the VP-level startups are not founders, they are recruited later, so there is often no equity but only options.

(4). Then there are the special core employees of the board of directors and consultants, which are generally in the range of 0.5%-1%.

(5). As for the other employees, everyone has basically counted them, but it should not exceed 0.5%.

Because the example we gave here is the A round, the company should not have too many employees, and the lower the employees, the lower the number.

Note that the percentage stated here is based on the company's existing outstanding stock sold as the denominator, not the total number of shares in the option pool as the denominator.

4. China's option pool through limited partnership

Finally, I briefly brought a little knowledge, that is, in US law, companies are allowed to reserve a part of the stock as an option pool in advance, and then slowly distribute them to employees. But in China, because Chinese law does not allow the practice of reserving shares in advance, it is more popular for Chinese startups to set up another limited partnership and let this limited partnership hold the company's stock, such as 15 %, and then employees take the share of this limited partnership.

In the cases we have done in the past, for example, the parent company is a US company and the subsidiary company is a Chinese company. In practice, we found that the operating principles of setting up an option pool in China or setting up an option pool in the United States are completely different.

To sum up, employee options and options in financial derivatives are two concepts that have the same root and the same origin but are now quite different, and should be distinguished. Restricted stock is for founders and options are for employees. The establishment of an option pool must be approved by the shareholders meeting and a complete set of documents must be implemented. We also introduced the share of the option pool in the company's shares, and the common share of employees at each level.

Now we have finished talking about the big framework of the option pool. After signing the specific option contract, the employee will get a thick stack of option contracts with many concepts, grant, vest, exercise, and the first year in 4 years. How about, what about the detailed regulations in the next three years, what do these mean, we will explain in detail in the next issue.