A properly selected Board of Directors and Board of Advisors can be an invaluable asset to an emerging company. Building these boards is an early opportunity for a company to gain credibility, industry contacts, experienced counseling and even access to cash.
A stock option or other equity incentive plan can be a company’s top recruitment tool in this regard, and if established early and administered properly, it can allow a start-up company to offer prospective independent directors and advisors a financial upside beyond what the company’s cash account can currently afford.
In counseling hundreds of emerging companies through this process, rules of thumb emerge that help provide guideposts for emerging companies. This article will discuss five of these rules of thumb.
1. Reserve 10-20% Of Your Company’s Outstanding Equity For A Stock Option Plan.
An emerging company should typically reserve 10-20% of its outstanding equity for a stock option plan. The options can be issued to independent directors and advisors as well as the employees.
2. Issue Options According To Value Added And Risk Taken.
Compensation should depend on the optionee’s value to the company, the prospects of the company, how far along the company is, and the track record of the founders. In any case, an outside director’s take typically falls between one-half of a percent and two percent, and an advisor’s between one-quarter of a percent and one percent.
3. Subject Director And Advisor Shares To A Two-Year Vesting Schedule, Vesting Monthly.
Gradually vesting a director’s and advisor’s options aligns compensation with actual service while protecting the company in the event that the director or advisor is prematurely removed from the board. Vesting should be automatically accelerated upon a change in control.
4. Set A Lenient Post-Termination Exercise Period When Possible.
If a director or advisor’s term is discontinued, a lenient post-termination exercise period may be very valuable to an option holder. Forcing the ex-director or advisor to exercise with no liquidity event in sight is not fair when options are the only compensation provided.
5. Try Not To Jeopardize Relationships.
Up-front communication of an independent director or advisor’s term of service and duties helps to foster a healthy relationship and facilitate a potential termination without jeopardizing relationships. When expectations are clear, everyone is happier.
Conclusion
Ultimately, equity incentive based compensation should motivate independent directors and advisors by offering them a vehicle through which they can profit. Simultaneously, a stock option or other equity incentive plan can help preserve cash, serve as a tool for recruiting talent, and offer a compensation structure that aligns incentives and promotes dedication to the emerging company’s growth and success.
Although the information contained herein is provided by professionals at Procopio, the content and information should not be used as a substitute for professional services. If legal or other professional advice is required, the services of a professional should be sought.
