Options in business:

A business is truly profitable when the entire team is committed to putting in the effort to drive earnings. For partners and co-owners, motivation is clear: their efforts directly influence the share of profits they will receive. But what about employees, especially top-level ones, who are on a salary? How do you motivate them when they simply want to sit comfortably without overexerting themselves?

This is where options come into play—a tool that gives employees the chance to earn shares or an ownership stake in the business if certain conditions are met. For Ukrainians, options are no longer an exotic concept; they’re already popular in the IT sector and among startups. However, in my six years of working with business partnerships, I’ve observed that entrepreneurs often misunderstand how options work, leading them to misuse them. As a result, this can do more harm than good for the company.

How Options Work

Simply put, an option is a promise from a business owner to allow an employee to access ownership of the company in the future, provided they meet specific conditions.

You can receive an option if you are:

• A top employee, rewarded for exceptional achievements
• Any employee, for fulfilling predefined conditions applicable to all
• A current partner or co-owner

How to Get an Option

From my experience, Ukrainian entrepreneurs typically use one or a combination of all three activation conditions for options.

Business loyalty: This refers to continuous work over a specific period of time. This period is known as the “cliff,” and only after it is reached can the employee redeem the first pool of shares. In Ukrainian companies, the cliff is typically set at 3 years.

It is important to clearly document when the option is activated. There are some cases where options start immediately, while in others, owners may decide to offer the option to an employee who has shown exceptional performance. In such cases, the terms of the options are often kept confidential and only disclosed to the selected employee.

Interestingly, even after the cliff period is completed, the employee may not receive the full share immediately. Instead, vesting is applied—a period during which shares are distributed in installments. A typical vesting period is 4 years, and during this time, the employee may redeem shares quarterly, semi-annually, or annually.

Outcome: Achieving Specific KPIs

KPIs (Key Performance Indicators) are set to ensure that employees achieve specific business objectives before receiving their options. These KPIs can vary widely, and in our experience, we have encountered conditions such as:

• Completion of projects within defined timeframes
• Sales targets
• Company turnover or growth
• Net profit within a set period
• Opening of new departments, locations, or expansion into new regions
• Reaching executive positions within a defined timeframe
• Proposing and supporting the launch of new business directions

Redemption Price: The Controversial Aspect

The redemption price is the most debated part of options. In paid options, employees must pay a specified amount to acquire the shares. Often, this price is determined at the outset. While the business may increase in value over time, agreements with the owners may allow employees to buy their shares at a fixed price.

Some business owners question this condition, as they believe setting a redemption amount—along with the loyalty period and achievement of CRIs—may turn the option from a motivational tool into a source of demotivation. On the other hand, other partners argue that anything received for free holds less value, which is why a redemption price is necessary.

What Does the Option Holder Receive?

The reward for an option holder depends on the specific form of the option granted by the company.

Here are the most common forms of options:

1. The Right to Purchase Shares at a Discounted Price: This classic option gives the employee the right to buy shares or a portion of the company at a pre-agreed price.
2. Grant of Shares as a Bonus: In this form, the company grants shares or a stake in the company to the employee as a bonus, according to an agreed-upon schedule.
3. Phantom Option: This form does not offer the employee actual shares in the company. Instead, the company issues “phantom” shares, which can be exchanged for a cash bonus in the future. This bonus can either be a fixed amount or a percentage of the company’s value at the time the phantom option is issued.

When to Implement Options

These rules can be combined and applied at various stages of a business’s lifecycle. However, it’s important to determine the right time to introduce options into your business.

I recommend that partners set this up early, ideally at the business creation stage, and include the possibility of granting options in the partnership or corporate agreement. Typically, a portion of the business is set aside specifically for issuing options in the future.

It’s crucial to remember that attracting top talent is often about more than just salary. A skilled individual who invests considerable effort into growing your company rightfully expects to not just be rewarded, but to become a co-owner of the business.

If you fail to define the conditions for issuing options early on, you risk losing out on valuable talent. I’ve seen clients face this exact scenario, where a key employee left a project due to the partners’ failure to establish clear option terms. In such cases, a talented individual may go to another company that properly recognizes and rewards their contributions.

When Options Pay Off

As a business owner, you should understand the three main advantages of options in attracting valuable talent:

1. Competing with Larger Businesses: As a startup, you can’t always compete on salary alone—large corporations can simply outbid you. But with options, you can offer a future bonus that motivates experts to join your company and work passionately toward earning that bonus.
2. Fostering an Ownership Mentality: Options help instill an ownership mentality in employees. They understand that their actions can drive the company’s success, and they should be rewarded for that. This is especially motivating during the early stages of business development, when the company is still small. Employees can receive larger shares, which could potentially make them millionaires down the line. Moreover, investors—particularly foreign ones—value the presence of options in a business, as it aligns the interests of employees with the company’s growth.
3. Filtering Out Disengaged Workers: Options act as a filter for individuals who aren’t fully committed to your business but are willing to work for a fixed salary. This helps you build your team with people who are motivated by the possibility of becoming future co-owners, rather than just taking a paycheck.

What Happens When an Option Holder Leaves the Business?

In my experience, there are instances where top employees, after receiving their options, lose their motivation. These employees may have worked hard, invested significant time and energy to achieve results, and finally earned their coveted shares. But after reaching that goal, their drive to continue creating or striving for more may sharply decline.

At this point, the employee may choose to leave the company and seek new opportunities that reignite their passion. So, what happens to the share they received?

1. Compulsory Sale: The option holder may be required to sell their share back to the company. The price at which the shares are bought back is determined in different ways. Sometimes it’s a fixed price set at the time of agreement; other times, the price is based on the company’s current value at the time of the employee’s exit. In some cases, owners may impose penalties for early exit, forcing the employee to sell shares at a minimal price (e.g., UAH 1).
2. Mandatory Lock-up: Partners typically don’t want a specialist to leave the business immediately after achieving results. This is why a lock-up period is often enforced, requiring the employee to stay for a set period after receiving their options. Lock-ups generally last from 1 to 3 years.
3. Lock-up with Replacement: In this scenario, the employee must not only work for a specified period but also find a suitable replacement with equivalent skills and prospects. The new hire must be approved by the other partners. This method is more complex and, therefore, less commonly used.

Conclusion

These are the basic rules every business owner should understand when considering options as a tool to motivate employees. While it’s possible to implement these rules independently, having an expert in partnership structuring or a lawyer can ensure the terms are legally sound and preserve the balance of your business.

In any case, you will likely need legal assistance—either upfront, when it’s most efficient and affordable, or later, when it might be too late and you risk overpaying for rectifying mistakes.