An attractive incentive: Do you know how stock options work?

Why do you stay in your job? Is it because of the interesting tasks, the good salary, your colleagues or the opportunities to develop?

There is rarely just one reason.

A wide range of factors come into play. This also means that employers need to focus on several areas if they want to retain their employees.

One of the more specialised tools companies can use is share-based remuneration.

There are many forms of share-based remuneration, but these are the three types we most commonly encounter:

• Stock options: Options give you the right to buy existing shares in the company at a later date at a price agreed in advance.

• Warrants: Warrants give you the right to subscribe for newly issued shares in the company at a predetermined price. They are used, for example, in start-ups where employees are granted shares as part of their remuneration package.

• Restricted stock units (RSUs): With RSUs, the employee receives a number of shares without paying for them, although remaining employed for a certain period is typically a condition.

It is important to note that both stock options and warrants are rights, so you are not obliged to exercise them.

Another common feature is that it often takes time before the options acquire real value.

Stock option agreements can therefore be seen as a kind of incentive: If you stay with your employer, a potentially significant financial gain may be waiting for you.

They vest over time

How far into the future that financial incentive lies varies from one agreement to another.

A typical stock option agreement is structured so that your options gradually vest while you are employed. The vesting period may, for example, extend over three, four or five years.

This means that you do not necessarily gain access to the full potential value at once. Instead, your right to exercise your options and purchase or receive shares is earned gradually.

At the same time, you may be granted new share options along the way. As a result, even after several years with the company, you may still have a significant number of options that have not yet vested. You may therefore lose them if you accept a new job and leave the company.

In other words, your employer has made staying extremely attractive.

You can leave, but what are you leaving on the table?

Many companies distinguish between a “good leaver” and a “bad leaver” in their stock option agreements.

The definitions of the two terms can vary. In general, however, a “good leaver” is an employee whose employment is terminated by the company for reasons other than the employee’s breach of contract. A “bad leaver” is an employee who resigns for reasons other than the company’s breach of contract.

It is important to stress that being a “bad leaver” does not necessarily mean that the employee has done anything wrong. It simply means that the employee has chosen to resign.

The agreements we typically see among Pharmadanmark’s members are structured so that if you resign and are considered a “bad leaver”, any stock options that have not yet vested will lapse when you leave.

If your employment is terminated and you are considered a “good leaver”, there may be various possibilities for retaining unvested stock options after you leave. This depends on the individual agreement.

What we often see is that the potential value of stock option agreements can amount to several hundred thousand Danish kroner.

For the individual employee, the question can therefore become very concrete: “Is the new job attractive enough for me to give up the potential gain from the options that have not yet vested?”

Remember that you may receive a new allocation of stock options every year. This means there may always be another potential financial gain on the horizon.

A golden cage or a win-win?

Stock options are sometimes described as a golden cage or golden handcuffs.

And that is actually quite an accurate description. There is no locked door. Employees are free to resign, and there are no restrictions on which competitor they can join, as there may be with restrictive covenants.

However, when leaving a company, an employee with a stock option agreement may have to walk away from a significant potential financial gain.

It is an effective way for companies to retain talented employees. At the same time, many employees also see stock options as a valuable opportunity.

If the company performs well, employees can share in the increase in value. This can quickly become a win-win for both parties.

Contact our legal advisers

If you are offered a stock option agreement, it is important that you understand the entire agreement. Understanding the vesting conditions and what happens when you leave is at least as important as looking at the number of options stated in the agreement.

You should also remember that potential value on paper is not the same as money in your bank account. The value depends both on how the company develops and on whether you still have the right to the options when they can be exercised.

We recommend that you always ask our legal advisers to review a stock option agreement before you sign it and again before you resign. We are ready to help, so do not hesitate to contact us.