Our insight

The untapped potential of employee stock options

At Index Ventures, we’re proud to back the most ambitious entrepreneurs, and support them on their journey to realize their vision.

We were born in Europe more than 20 years ago, and today we have feet firmly planted on both sides of the Atlantic. From our hubs in London and San Francisco, we use our deep knowledge to invest in outstanding startups. We have 160 companies in our portfolio, equally split between Europe and the US.

World-changing tech companies can start anywhere – but we recognise Silicon Valley’s sophisticated model of scaling and investing in startups as second to none. We adapt and apply best practices from Silicon Valley to our startups in Europe, to prime them for success.

One of the key ingredients is employee ownership. In Silicon Valley, employee stock option grants have helped attract the world’s best talent to small startups with limited cash, but near limitless potential. The result is that these startups have the people they need to succeed early on.

In Europe, employee ownership is less common – and there has been no clear playbook for startups to follow. This is exacerbated by the complexities of doing business on a continent made up of 30 different countries, all with different cultural norms, regulations, tax incentives, and so on.

This handbook is designed to help European founders make critical decisions. Who do you offer stock options to? How many? When? How do you adapt your policy as you grow, and as you move into different geographies? How can you ensure employees understand the scheme?

We’ve included the basic information you need to design your stock option plan and policies, ready-to-use allocation models, and advice from those who’ve been through it – plus our own perspective as investors. You’ll also find case studies from Index portfolio companies throughout the book, demonstrating the range of best practice. Founders and executives from the likes of Farfetch and Elastic share their approaches to employee ownership, their successes and their mistakes, and the valuable lessons they’ve learned in the process.

We chose to open-source our work, so you can read or download the entire Rewarding Talent handbook from our website at: www.indexventures.com/rewarding-talent

Alongside this handbook, we’ve developed the OptionPlan tool, which will help you determine option allocations for your entire team, whether you’re at seed stage or Series A.

You can also find it on our website at: www.indexventures.com/optionplan

Our take

Bringing employee ownership to Europe

At Index, we believe that a fresh approach to employee ownership is key to creating European tech giants on the scale of Google or Amazon. Until then, too much of Europe’s top talent will simply join the European arms of US firms, relocate, or stick to lower-risk corporate jobs.

In the US, option grants are driven by intense competition for talent. There are established benchmarks for option grants to employees at all stages and levels. Thousands of employees across hundreds of startups have benefited financially following company exits. Many have been inspired to become founders or angel investors themselves, creating a virtuous cycle of innovation and startup activity.

Europe has seen fewer exits, and option grant benchmarks haven’t been available, so founders have been forced to make up their own rules. But competition for talent is heating up, and with more high- profile exits, individuals are more willing to exchange cash for stock options, especially in major tech hubs.

We therefore expect the next generation of European startups to offer options more widely to employees. By staying ahead of this trend, startups can attract and retain the best talent out there. However, this must be coupled with changes in national policies, which encourage the use of stock options across the continent.

The methodology

How we put this handbook together

This handbook is based on what we believe is the most extensive research ever conducted on employee stock options in European startups, which included:

• Cap table analysis by funding round across 73 companies in the Index European portfolio

• Analysis of over 4,000 individual option grants from more than 200 startups across Europe and the US, supported by Option Impact from Advanced HR

• In-depth interviews with founders, CFOs and executives of 27 Index-backed European companies from seed stage to post-IPO

• Survey on ESOP practices completed by executives from 53 European startups and former startups, representing over 11,000 total employees

• Review of regulatory and tax policy in the US and key European and global markets, supported by Taylor Wessing, Wilson Sonsini, and several other law firms

Introduction to this edition

There was a tremendous response from the European startup ecosystem when the original Rewarding Talent handbook and OptionPlan app were released in December 2017. One year on, it has become the ‘playbook’ for European entrepreneurs. We are now delighted to release this updated and expanded edition.

Recognising that startups need to hire and motivate top talent right from the outset, we have expanded our research and recommendations to cover equity allocations for seed companies. We have also added a new case study from Elastic. Guidance on topics including retention grants and strategic advisors has been enriched.

You will also find guidance on stock option practice and policies for twelve additional countries, within Europe and beyond.

Finally, we are making specific recommendations for policymakers. We see their role as crucial in helping to create a regulatory environment which fosters entrepreneurship and innovation.

If you have feedback, please reach out to Dominic Jacquesson at talent@indexventures.com

Key findings

A top-level summary

We found big differences in employee ownership between the US and Europe. They are presented throughout this book, but here are a few key points.

1. European employees own less of the startups they work for than US employees.

   For late-stage companies, they own around 10%, versus 20% in the US.

2. Employee ownership levels vary much more in Europe than the US.

   In Europe, employee ownership in late-stage startups ranges from 4% to 20%. In the US, ownership is more consistent, as stock option allocation is driven by market forces.

3. Ownership rules adopted by startups vary between Europe and the US.

   For example, provisions for leavers, and accelerated vesting following a change in control.

4. In Europe, stock options are executive-biased.

   Two-thirds of stock options are allocated to executives, and one third to employees below executive level. In the US, it’s the reverse.

5. European employees still don’t expect stock options much of the time.

   US employees joining a tech startup with fewer than 100 staff will expect stock options straight away. This is much less true in Europe, although expectations are steadily rising.

6. European founders haven’t known how to allocate stock options across their team.

   Benchmarks are available in the US, guiding founders to make compelling grants. These haven’t been available in Europe, where founders have been ‘flying blind’.

7. European option holders are often disadvantaged.

   In much of Europe, employees need to pay a high strike price, and they will be taxed heavily upon exercise as well as sale. Leavers often get nothing.

8. There is wide variation in national policy across Europe, with Estonia, the UK, and France most supportive of employee ownership.

   Regulations and tax frameworks are radically different across Europe. Estonia has the most favourable approach of any country reviewed globally. The UK’s EMI scheme and French BSPCE’s are both better than what is available in the US. Other countries, including Germany, lag behind.

9. Employee ownership correlates to how deeply technical a startup is.

   An AI or enterprise software startup requires more technical know-how than a straightforward e-commerce startup. These employees are at a premium in today’s economies, and more likely to seek stock options.

10. Salary differences between startups and established companies are narrowing.

    Startups still pay lower cash salaries, but competition for talent is forcing them to narrow the gap. Stock options are ever more important to hire and retain top talent.

At Index, we are focused on helping founders to address these challenges. There has already been a noticeable change in approach since we launched this handbook in December 2017.

We will continue to argue for progressive, pro-innovation thinking from investors and policymakers across the whole of Europe.

Stock options 101

A top-level summary

Options are a special type of contract. They grant the holder the right – but not the obligation – to buy or sell an asset at a set price, on or before a certain date.

In established US practice, stock options grant the holder the right to buy shares (exercise their options) at a set (or strike) price, within a ten-year period.

The option allows the owner to buy a certain number of shares. The right to exercise will vest over a four-year period; typically, there will be a one-year cliff before the holder has any rights, then vesting will be linear, allowing the holder to buy a further 25% of their shares at the end of years one, two, three and four.

If they want to exercise their options, the holder must pay the exercise price (strike price x number of options). In return they will receive ordinary shares in the company. The holder may be able to sell these shares immediately, or retain them in the hope that they will further appreciate in value.

It only makes sense to exercise options if the current share price of the company exceeds the strike price. Exercise requires a cash payment, so the decision to exercise also depends on how long the holder thinks they will have to wait before they can see a cash return by selling the shares. Any tax incurred will also influence this decision.

Stock options are the instrument of choice for employee ownership in US startups. They are better than giving shares to an employee because there is no premium or tax to pay upfront, making them risk-free for both employee and company.

In Europe, the rules and tax treatment of stock options varies widely between countries. In some countries, it still makes sense to use stock options. In others, alternative instruments are used instead. But in each case the purpose remains the same – to incentivise employees, by rewarding them if the company’s value increases.

To keep things simple, we’ve referred to all of these instruments as ‘stock options’ in this handbook, even though their legal status may be very different. These include warrants, Restricted Stock Units (RSU), and virtual stock options.

You’ll find a detailed glossary of legal and financial terminology in the Appendix.

Employee ownership:

Why it matters

As a founder, the equity in your company is your most precious asset. You should be unwilling to give it up lightly. But you also need to leverage it wisely, in order to access the two things that are essential for success – financial capital, and human capital.

Ambitious founders know that talent is their key bottleneck, and that building a world class company requires a world class team. In a competitive talent market, where FAANGs, BATs, banks, and corporates can offer high salaries and generous benefits for top candidates (especially in technical roles), it can be daunting to compete.

However, as a startup, you have two big advantages. Crucially, you can offer a compelling culture and mission. Your employees can feel part of a close- knit team, directly involved in shaping something truly innovative, rather than feeling like cogs in a machine.

But you can also offer a more tangible benefit. Ownership, in the form of stock options. Giving your team the opportunity to own a stake in a company that could become highly valuable a few years down the line, and to participate in the financial upside that could result, is a compelling proposition.

With less cash at your disposal for salaries, especially in the early days, stock options are also given to employees in lieu of the cash compensation and benefits that they might receive at larger companies. This enables smart founders to secure the best talent available.

In fact, offering stock options can benefit founders in several ways.

Hiring

Helping you secure the best talent, even when you’re up against companies with much deeper pockets.

Retention

Once you’ve hired top talent, you need to hold onto it. Stock options vest over multiple years, appreciate in line with your valuation, can be topped-up, and create disincentives for leaving. This gives your employees ongoing reasons to stick with you.

Motivation

Having a personal stake in the success of the company encourages employees to work harder and be more ambitious.

Alignment

Stock options direct all employees towards the same goal – the company’s overall, long-term success. They act as an incentive for collaboration.

Using equity wisely

Diluting your equity is only worthwhile if it truly allows you to hire, retain, motivate and align the very best talent.

If your stock option program is perceived as unfair, inconsistent, unreal, or is simply not understood, cynicism can set in. You will have given up your most precious asset, without obtaining the benefits. It is critical that your employees understand what stock options are, and perceive their grants as contractually protected, and objectively and fairly awarded across the team.

This is the driver behind much of the advice in this book: adopting a formula-driven system for awards, strengthening rights for leavers, and being more open with your employees. More traditional European lawyers and advisors often propose approaches and grants which are biased in favour of the employer, but we invite you to be more enlightened. In our experience, rewarding talent meaningfully and fairly is not only warm and fuzzy, it also makes business sense.

The Silicon Valley flywheel

Employee ownership pulls in top talent

Employee ownership has been at the core of Silicon Valley thinking for over 30 years. The story of the part-time masseuse who joined Google in its infancy, and ended up a millionaire, has now been played out thousands of times, in all sorts of startups. This has drawn thousands more talented employees into the startup ecosystem.

Employees from successful startups often go on to start their own companies, or invest in the next generation of startups as angels. A cycle of entrepreneurship is fostered.

Employee stock options are standard practice in Silicon Valley and across the US, where grants are driven by the market. Widely available benchmark data helps founders determine grants for any given role at each startup stage.

In contrast, levels of adoption vary across Europe. Grants here are mainly determined by the founder’s philosophy: the culture they want to create, and how mission-driven they want to be. A lower risk-appetite on the part of talent, and onerous regulations and taxation, feed into an environment where employee ownership is low..

Ambitious founders should think and act globally from day one. This starts with a forward-thinking, consistent approach to employee ownership. Sharing the pie with employees – in other words, offering them equity – is a great way to grow the size of the pie over time.

Staying ahead of the curve

A message to European founders

In much of Europe, it is still possible to get a startup off the ground without giving your team stock options.

But expectations are rising, particularly in major tech hubs such as London, due to the growing number of big exits of VC-backed startups. Employees are more likely to know others who have benefited from stock options, and want to ‘get in on the action’. If you offer options proactively, you can hook in the very best people and access talent that you would not otherwise have been able to reach.

At least as importantly, stock options are a way of retaining talent as you scale. In a few years’ time, if you continue to scale and raise brand awareness, your team’s success will make them hot targets for other companies looking to poach. If you have not built in sufficient upside and retention options, individuals crucial to your success are likely to be tempted by better offers elsewhere.

It is our view that the next generation of successful European startups will not achieve greatness if they do not effectively reward talent through the use of stock options.

Founders, investors and employees

A startup’s success depends on three groups of people: founders, investors, and employees.

You – the founder or co-founder – are the visionary, and the final decision-maker.

Investors place their faith in you and your vision, contributing capital to kickstart and scale your business, and offering advice and expertise along the way.

Your startup is only as great as the people building it – your employees. It’s a big risk to join an unproven business like yours, especially when well-established companies offer similar, more assured positions. Employees are your most valuable asset, and you need to treat them accordingly.

Together, these three groups determine the fate of your company. Company ownership is a great way to recognise and reward everyone’s commitment.

Cap tables

Your cap table breaks down your company’s ownership. It lists all the shareholders, and the number, class, and percentage of shares each holds.

Founders and investors are the main shareholders. This includes early investors, such as friends, family and business angels, and later investors, such as venture capital funds. If you issue stock options to employees, you’ll have an ESOP on your cap table, representing the total option pool available.

All too often, we’ve seen founders make regrettable decisions during early capital raises: giving away too much equity too soon, or on unfavourable terms. These mistakes can unnecessarily dilute your stake in the company and make it difficult to attract further funding.

How ownership evolves over time

From one to many

Funding rounds are a useful proxy for the stage and scale of a startup, as it moves from seed to Series A, Series B and beyond. However, there is a lot of variation between startups at each stage. For the purpose of having a shared understanding, the table below sets out some typical characteristics of Index- funded European startups at each stage:

On day one, you (and your fellow co-founders) will own 100% of your company’s shares. As you raise capital from third party investors, you’ll issue additional shares. And as you hire employees (or advisors), you may offer them stock options. Stock option holders are not shareholders.

They appear on a separate line on the cap table (in your ESOP). The total number of issued shares and outstanding stock options in your ESOP is known collectively as your fully diluted equity (FDE).

The impact of dilution

When you raise additional capital, pre-existing shareholders are diluted. This dilution is proportional to the amount of capital raised, and inversely proportional to the company valuation you achieve. Any options granted to an employee at any point in time are diluted in the same way.

This level of dilution might appear unattractive to an employee granted options early on. But it doesn’t take account of valuation increases as the company scales up and attracts further funding. In other words, an early employee’s options will convert into a smaller percentage of the company, but may still be worth more in dollar terms. The table below shows the impact of dilution on a seed-stage hire, initially granted options over 1% of the company’s FDE. It also shows the notional gross value of these options, for a strongly-performing startup as it scales.

An employee owning 1% of the company’s FDE in common shares at a notional gross value of $100,000, will own only 0.40% of the company at Series D, as a result of dilution. However, the value of this diluted stake might be as high as $2 million. This shows how valuable stock options can be.

ESOP size

How much should employees own?

How much of your company’s FDE should you set aside for your ESOP? If you already have an ESOP component in your cap table, should you top it up?

You’ll need to answer these questions as part of each fundraise.

ESOP size is a board-level decision. Given the legal and administrative overheads, you won’t want to revisit it between rounds of funding. So the size of your ESOP should aim to cover all your potential talent needs through to your next round.

You’ll need to tread a careful balance. You want to make sure your ESOP allocation is sufficient, but if you over- allocate, you risk diluting your stake, and your existing investors’ stake.

The table below shows an indicative example illustrating the impact of ESOP size on shareholder dilution at Series A, whether at 10%, 15% or 20%.

In theory, you should base your ESOP allocation on your hiring plan through to your next fundraising. However, sticking to a plan for 12 – 18 months in the future might feel over-ambitious.

In any case, unexpected opportunities or challenges are bound to impact your hiring plan. Your company might grow quicker than expected. Or, you might meet an executive with huge potential to transform the business, who expects a substantial option grant.

In practice, most founders take a top- down approach, and VC investors will expect your ESOP to be sized at a round figure.

ESOP size at seed

Traditionally, ESOPs are set to 10% at seed. This is the recommendation of Seedcamp, and still the norm in both Europe and the US. However, some accelerators, including Y Combinator and The Family, now advocate 20%. They recommend that seed investors should increase their valuation of the company to accommodate the larger ESOP.

This doesn’t mean you should allocate or promise all of this amount to your early employees. But it recognises the importance of stock options for securing top talent when company cash is particularly constrained.

The composition of the founding team can also influence what is the right ESOP size. For example, if you are:

• A solo founder who needs multiple key hires

• Co-founding team thinking of outsourcing early development versus hiring engineers

• Lacking a technical co-founder, and need to hire a non-founding CTO

If your focus is on leading-edge technical challenges (such as Internet of Things hardware) or deep tech (such as virtual reality or AI deep learning), you’ll need a large and exceptional technical team.

Competition for such talent is fierce. And you’ll be contending with the deepest pockets around – including Google, Facebook, Amazon and Apple. These hires will expect high offers of equity participation, so you’ll be likely to need a larger ESOP than average.

ESOP size at Series A and beyond

In the US, ESOPs are typically increased from 10% at seed to 15% at Series A. The ESOP then grows with each funding round – reaching 20%, or even 25%, by Series D. The ESOP is topped up to provide more firepower, as more employees are hired and leadership teams are put in place. This pattern is illustrated in the company ownership graph earlier in this chapter.

In Europe, whilst seed ESOPs are also usually set at 10%, our research indicates that, on average, this figure doesn’t rise with successive funding rounds. Instead, the ESOP ‘flat lines’. It gets topped back up to 10% at each stage, after accounting for the dilution of existing option holders. We also found a much wider range than in the US, with ownership between 4% and 20% by Series D. But this means that on average, European employees end up with only half as much ownership in later stages, compared to their US counterparts.

We believe this difference is a key issue in the European startup ecosystem which needs to be addressed. We identify four key reasons behind it:

• Government policy

• Risk appetite – of talent

• Mindset – of entrepreneurs and investors

• Lack of benchmarks

Our aim at Index is to address each of these factors, increasing employee ownership in Europe through the research and recommendations in this handbook.

We can also validate ESOP size bottom-up. We’ve set out a plausible scenario for your Series A hiring plan and individual allocations in the OptionPlan app that accompanies this handbook. We also apply this scenario in chapter 6. If you were to follow this scenario entirely, you’d need a 12% ESOP to cover your needs up to your Series B fundraise.

It is extremely unlikely that your company’s situation will exactly match our default scenario. So we recommend using our OptionPlan app to customise your own option plan, and to more accurately gauge the size of ESOP you need. However, it is very likely to fall within the range of 10 –15%.

We have also modelled ESOP size requirements beyond Series A, into Series B and Series C. This combines the OptionPlan benchmarks for grant sizes with our experience of hiring trajectories. It projects an average ESOP size for the next generation of successful European startups set at 12% for Series A, rising to 14% for Series B and 16% for Series C.

Source: Index Ventures analysis

We have already discussed how ESOP size can be affected by the composition of your founding team, and how deeply technical your company is. But there are two other significant factors in Europe to consider.

Your philosophy

What kind of company culture do you want to create? How mission-driven will you be?

You might mirror a Silicon Valley mindset, using equity to win and retain the best talent, and encourage alignment across your team. To offer options to all employees, including large options to attract exceptional individuals from major companies, you’ll need a substantial ESOP.

If you’re more concerned about dilution, you can consider offering higher cash compensation to employees instead. You might also hire less experienced individuals you believe will grow into their roles, as they’ll be less likely to expect large stock option grants.

Where you are

Generally, the size of a company’s ESOP is closely linked to the maturity of the local ecosystem. In regions that haven’t seen many high-profile successful exits, people are less aware of – or perhaps more sceptical about – the potential value of stock options. Whereas thriving local ecosystems create more competition for talent, which means startups must offer larger grants to secure the best people.

Unsurprisingly, London – Europe’s largest startup hub – has the highest expectations overall in Europe. Across the rest of the continent, there’s a very mixed picture. In some places, legal and tax rules also affect the attractiveness of options. (See chapter 7)

We expect these dynamics to shift over time, but the direction of travel is clearly towards rising employee expectations in all geographies.

You will have carved out space on your cap table for your ESOP as part of your seed fundraising. However, you cannot make any stock option grants until you have legally created your ESOP plan, and chosen the rules governing how it operates.

In the US, ESOP plans will typically be formalised after a seed round, and sometimes even earlier. There are generally accepted guidelines to follow and the legal costs are low. Startups would also find it challenging to make any hires without being able to formalise stock option grants immediately.

In Europe, the costs of setting up a plan are often higher, and early hires can usually be secured on the basis of informal promises of stock options. So it is common to see ESOP plans formalised following Series A fundraising.

Your board will need to approve your ESOP rules. It’s important to make them as clear and consistent as possible, so you can avoid changing them or creating exceptions later on. This chapter covers the major rules, particularly where there are significant differences in practice between Europe and the US.

Vesting schedules

Consider a back-loaded vesting schedule

If stock options could be converted into shares immediately, they wouldn’t be effective for retaining employees. A vesting schedule allows employees to accumulate their stake in the company and exercise more options over time.

If an employee leaves the company before they are fully vested, they will retain rights over their vested portion. The unvested portion is cancelled and returns to the unallocated ESOP pool.

The cliff

Typically, no options are vested during the first year (called the ‘cliff’). This gives companies time to weed out mis-hires without suffering dilution.

The traditional four-year vesting schedule

A four-year vesting period is standard practice in both the US and Europe, and tends to be the same regardless of role or seniority.

Vesting is generally linear, with 25% immediately following the cliff, 50% after two years, 75% after three years and 100% after four years.

In the US, vesting is almost always monthly after the cliff, for specific tax reasons. In Europe, vesting is often monthly too, but can be quarterly or annual, to reduce administration.

Alternative schedules

In recent years, alternatives to this traditional model have emerged because the time-based formula has been criticised for emphasising the closing of hires, over longer-term retention. The perception is that this has rewarded ‘job hopping’, with employees staying through their cliff, but moving on at the first sign that the company’s growth prospects might not be spectacular.

When an employee leaves a company, so too does their knowledge and experience. Companies appreciate that stock options need to be structured to encourage long- term retention as well as to simply secure hires in the first place.

This has led to two alternatives to the traditional vesting schedule: back-loaded vesting, and performance-based vesting. We expect to see more examples of European startups experimenting with these options in the coming years.

Back loaded vesting

Instead of giving employees a quarter of their options per year, Amazon gives its employees 10% in the first year, 20% in the second, 30% in the third and 40% in the fourth. Similar approaches have been adopted by Snap and several European companies, including Farfetch.

In European startups, it can make even more sense to introduce a back-loaded vesting schedule for option grants. This is because grants are used much more as a way of retaining, than of hiring talent. Few candidates will question an offer because of a back-loaded vesting schedule. But many may be encouraged to remain at the company in order to maximise their vesting. We encourage European founders to seriously consider back-loaded schedules.

Source: Option Impact from Advanced HR (US data), Index European ESOP survey

Performance-based vesting

It’s becoming more common to reward executives with performance-based stock options, rather than time-vested ones. This means employees are only given stock options if they hit targets that drive your long-term value, like revenue growth.

This approach normally comes with two caveats.

First, it only applies to senior executives, in roles that impact your top-line goal, like sales and marketing.

Second, it’s still a good idea to use a traditional, time-based system for up to half of their stock. This is because there may well be external factors outside the control of a single executive which affect performance targets.

Strike price

Go for the lowest strike price

In some European countries, such as Germany, strike prices are set based on the latest fundraising valuation. In others, notably the UK and the US, you can offer grants at a reduced strike price without any tax penalty, by obtaining a ‘fair market valuation’ (FMV), which will be recognised by tax authorities.

While tax-assured valuations may not be available everywhere, get legal advice to see what flexibility is possible. In several countries, whilst valuations may not be tax-assured, there are precedents for offering reduced strike prices, which are unlikely to be challenged later on. Your aim should be to maximise your employees’ upside, without the risk of incurring a large tax bill.

Some founders and investors believe a discounted strike price misaligns employee and shareholder interests. We don’t agree. By obtaining the maximum discount possible, you give employees more financial benefit – and stronger motivation – per option granted. It also recognises that stock options convert into ordinary shares, which are fundamentally less valuable than the preference shares that investors generally hold.

Additionally, if your company goes through a bad patch and you’re forced to take funding at a lower valuation, the options may still be valuable. It is also in your interest to have a low strike price as sophisticated individuals will realise that higher strike prices imply less benefit, and will therefore push for larger grants – using up more of your ESOP.

Leavers

How to handle leavers’ options

What happens to the options of employees who leave your company before you reach a liquidity event?

The skills you need at the start of your company are very different to the ones you need later on. Sector-specific and managerial skills tend to become more important as your business grows. Company cultures evolve, with an unstructured environment giving way to more refined processes.

You might not need or even want an employee to stick with you all the way to an IPO or exit. And early-hires might also want to move on, for reasonable personal or professional reasons.

This doesn’t need to be a bad thing. You should acknowledge the contribution these early employees made to get you to your current position, and aim to leave on good terms. This way, your former employee remains an ambassador for your brand.

Facilitating leavers to exercise their vested options is a great way of achieving this. Conversely, preventing them from exercising can be poisonous for relationships.

However, choosing the right policy for your leavers is complicated by questions of taxation, strike price, and headaches that come with having minority shareholders. These challenges vary hugely from country to country, so there is no single ‘right approach’.

US – 90 days

In the US, employees who leave typically have 90 days to exercise vested options. After this, any remaining options are forfeited. In a private company, this means individuals must quickly decide whether to take the risk of using cash to buy an illiquid asset. Depending on the number of options and strike price, this may be unaffordable. In the US, exercising options may also trigger a tax liability, depending on the income of the individual and size of the gain at exercise – even if the shares aren’t immediately sold.

This practice can make leaving a company prohibitively expensive. If an employee joined early, the strike price may be very low – a 60% discount on the last-round valuation is not uncommon – but exercising options can still be expensive. In the example we used earlier, an employee granted 1% of FDE as options at seed stage, at a seed-round valuation of $10m, would need $40,000 to exercise all their options. A tax bill could add to the financial burden. It may be years before the company exits and these shares can be sold – and there’s always the risk that the company loses value, or fails.

A few US companies are now adopting extended exercise periods, to appeal to savvy candidates who understand the implication of leaving before an exit. For example, employees may be given an additional year to exercise, per completed year of tenure after their cliff. This approach gives the employee time to secure the cash to exercise, and to better gauge the company’s trajectory. It thereby helps to build an employee-friendly culture and attract new hires.

Europe

Our survey of European startups shows a more mixed picture than in the US. As you can see in the chart below, almost half of European startups (particularly outside the UK) allow leavers to retain their vested options, but without the right to exercise them until exit.

That’s because, in much of Europe, minority shareholders must be consulted ahead of major company decisions. If leavers exercise their options immediately, the number of shareholders grows, which can create major administrative headaches.

Furthermore, strike prices in most of Europe are high, and tax liabilities after exercise can be much higher than in the US.

Allowing leavers to retain their vested options avoids both these problems, but it leads to a perverse incentive. In effect, leavers benefit from continued increases in the share price, with neither personal involvement or financial outlay, since they don’t have to pay for their shares upfront.

These factors rarely apply in the UK – but even so, more than 25% of startups offer the same terms.

On the other hand, a few companies in our ESOP survey have the drastic policy of dissolving all options for leavers, whether vested or unvested.

We advise that you tailor your leaver policy according to the specific situation in your country. Your guiding principle should be generosity, wherever possible, giving leavers a realistic opportunity to exercise and become shareholders.

But also try to avoid situations where leavers retain all the benefits of staying at zero cost. One innovative solution, for example, is to allow leavers to retain vested options without exercising, but to ‘cap’ the upside that they can achieve – e.g. applying the share price in the funding round immediately before or after they leave.

Source: Index European ESOP survey

Good and bad leaver provisions

ESOPs provide mechanisms for cancelling the exercise rights of ‘bad’ leavers. In Europe, this mechanism is often discretionary. People fired for major disciplinary breaches, or who leave to join a direct competitor, almost always fall into this group. Quite often it also applies to those who simply choose to leave, or those terminated for poor performance.

It’s very different in the US, where there are very tight restrictions on who is considered a bad leaver; typically involving dishonesty, fraud, negligence, or breach of confidentiality. In fact, bad leaver provisions for stock options are usually tighter than those in employment contracts or covering health and pension benefits. Options are considered a core part of an individual’s compensation, and cannot be clawed back by the company.

We strongly support founders following the US approach on leavers, to reassure employees and demonstrate the real value of options. As stated earlier, if employees become cynical about your options program, it ceases to be a benefit, and in fact can become symbolic of a poor culture. Thankfully, we’re now seeing companies in Europe following this advice, and reducing bad leaver provisions.

Change of control and acceleration provisions

Minimise accelerated vesting

ESOP rules will spell out what happens to employee options during a change of ownership – i.e. a merger, acquisition or IPO. In such a scenario, standard US ESOP terms dictate that vested options become exercisable. New owners purchase them on the same terms as they are offered to all shareholders, whether that means cash, shares in the new company, or a mixture of the two.

During an IPO, shares from exercised options become tradeable shares in the listed company. Unvested options will generally continue to vest following IPO.

In an acquisition, an acquirer will typically put in a new retention programme for key employees, and unvested options lapse.

Exceptions are sometimes made for key executives, or the executive team as a whole. In particular, the CEO, CFO and General Counsel are often subject to acceleration provisions, which partially or fully accelerate the vesting terms for their option grants. This is because these individuals are critical to a successful exit. Without acceleration rights, they have an incentive to delay until their options are fully vested.

In such cases, there’s usually a ‘double-trigger’ acceleration provision: acceleration only happens if there’s both a change of control and that individual is terminated or demoted. This protects against new owners who terminate – or effectively terminate – key executives after taking control, thereby preventing them from vesting further options.

Acceleration without a double trigger, and acceleration for non-executive staff, are both rare in the US. They reduce the sale proceeds for each common stock shareholder and as a result are deterrents to potential acquirers. In fact, the risks can be even higher for an acquirer, since your team is often the most valuable asset that they are paying for. If key members of this team stand to make unexpected additional gains at the moment of acquisition, the risk that they choose to leave the company is particularly high.

The European picture is different. One third of European startups offer full accelerated vesting to all employees, which would be unheard of in the US. It’s not clear why this is, but it seems to have become standard wording in many legal templates.

We recommend at most, double-trigger partial acceleration limited to the executive team only. A broader acceleration policy could seriously impede your chances of a successful exit.

Source: Index European ESOP survey

Watchlist: share capital and transfer restrictions

Protecting your stock

Share capital

Your startup might begin with a relatively limited number of authorised shares in the thousands, or even hundreds. We recommend increasing your share count via a stock split as part of your Series A fundraising. While there’s no perfect number, 10 million is a good figure to aim for. This won’t affect dilution: existing shareholders will simply get an extra zero or three zeroes on their current holdings.

Increasing your issued share capital will allow you to be more precise with your option grants, particularly with junior staff, who are likely to receive less than 1/1000th of your FDE. Plus, it’s psychologically more encouraging to receive a grant measured in the hundreds or thousands of individual options, rather than just one or ten, even if the overall ownership level is the same.

Transfer restrictions

A lack of local regulation can make it relatively easy for employees to sell exercised options, without approval, on secondary markets. We therefore recommend you introduce transfer restrictions in your company’s articles of association, and in your ESOP plan rules themselves, which require employees to seek board approval before selling any shares.

More and more companies are implementing robust restrictions to limit trade in the secondary market. There’s more on this in chapter 9.

How much, and who gets it?

It’s not easy to determine how much equity employees should get – particularly if you’re a first-time founder. In Europe, there’s not much benchmark data. Often, all you have is a gut feeling, and the views of a small handful of advisors. This chapter, and the next, aims to close this critical knowledge gap.

When it comes to employee stock options, there are a few big questions that almost all founders ask, regardless of sector, stage or market:

• ‘How much equity should I give to new hires?’

• ‘How do I deal with the differing expectations for different roles?’

• ‘How do I design a system that will be consistent and fair in the long run?’

In this chapter, we will address this set of questions at seed stage. In the next, we will move on to consider grants for Series A employees.

Striking a balance

At seed stage, you will be hiring your first few employees – probably no more than ten.

Your company will have few formal processes. You’ll still be iterating your product offer, target market, and business model. So your employees will need to be highly flexible. You won’t necessarily have formal hierarchies or job titles, as you’ll still be figuring out both the skills you need, and the skills you have in your current team.

Compensation packages for your early team need to strike a balance. On the one hand, money will be tight, which makes options an attractive way to compensate your team. On the other, you don’t want to give away large chunks of your business to people whose contribution is unproven.

This is a conundrum, and it comes at a time when you want to be focusing on your product. So, like many aspects of running a startup, it can feel more like an art than a science.

The dangers of IOUs

Think twice before making vague promises

In the US, it’s common for companies to establish a formal ESOP as part of their seed funding round, and to start making formal allocations and grants. In Europe, where the costs and complexities of ESOP setup can be greater, this is less likely. However, it is becoming more popular, and we recommend it whenever possible. Increasingly, experienced talent will not join a company without a formal stock option offer.

It’s easy to run into problems with option grants when you have no formal ESOP in place. Any agreement you make is essentially an IOU – a loose commitment to offer something in the future.

This means you should be extremely careful, ensuring that any offer is clearly understood by both parties. Some founders make the mistake of agreeing equity terms on a handshake, and while this is often done in good faith, it can come back to bite either party.

Best practice: dos and don’ts for early stage equity discussions

Allocation considerations and benchmarks

How much to give to early employees?

On average, startups that approach us for seed funding have ten employees – but it can be anywhere between zero and twenty. This early talent may well determine the company’s ultimate success or failure. They are also the ones taking the biggest personal risk.

If they’re experienced software engineers, or have taken a large pay cut to join, they will likely expect some level of ownership, even in Europe. Four or five of the first ten employees in a typical European tech startup could be experienced technical hires. So you’ll probably be forced to think about equity, even if you can’t grant formal options yet.

There’s no definitive answer here. But US benchmarks for seed-stage option grants (see table below) can be a useful guide – bearing in mind that European employees are generally less willing to compromise on cash compensation in return for more stock options.

Salaries have a natural ceiling at seed stage, due to cash constraints. This even extends to Silicon Valley, with an the upper-limit of $120k, even for ex-Google engineers previously earning $200k+. For experienced hires such as these, the only way to compensate them is through generous stock option grants. In Europe, $80–90k (€75k, £65k) sets a more realistic ceiling for top salaries.

European candidates on average are more risk-averse than those in the US, and may be less willing to compromise on salary. For junior hires, salaries tend to be closer to market value, since people still need to pay their bills. Stock options awards are correspondingly lower.

The size of your seed round also has a big impact. Seven years ago, seed rounds were less than $1 million, creating a very strong downwards pressure on salaries, the largest cash expenditure for most startups. Nowadays, seed deals can sometimes look more like a small Series A, with $4 or $5 million raised. This gives more flexibility for hiring plans, and salaries.

The grids below provide potential salary levels and option grants expressed as a percentage of salary. We believe these values are realistic for a European seed startup with ambitions to succeed in attracting quality talent. But it’s important to remember that there is no magic number.

Calculating initial grants

Our OptionPlan app will help you

We have developed a 6-box grid to help you calculate grants for employees below executive level – the two axes being seniority and technicality. We have also benchmarked salary information to get you started.

We encourage you to use our OptionPlan app to compare a set of six benchmark percentages for seed startups, and how these translate into grant sizes, ownership, and potential upside value.

Visit www.optionplan.com

Significantly larger grants, at the 2% or even 3% level, might make sense in specific situations. For example, if you are a solo founder who needs to hire in a wider range of experienced skill-sets to complement your own. Or a deep-tech company that needs highly sought-after machine learning, AI or VR developers.

For a typical seed team of ten employees, which we include in the OptionPlan default settings, these grants add up to 5% of FDE at a $6m post-money seed valuation. This total of option grants at seed stage is in fact close to the US average, and compares to a current European average closer to 3–4%.

In the US, it would be unusual for employees hired at seed stage not to receive options as part of their job offer. In Europe, it’s probably more like four of the first ten. And it’s not unusual to see no equity promise at all.

We believe that all employees at seed stage should receive stock options in Europe. Grant sizes may be lower than those above, if you are paying closer to market salaries, and if you are in a less mature ecosystem. OptionPlan’s different benchmark settings can help you to gauge the balance correctly.

Once you reach the milestone of a Series A fundraise, you will need to start standardising your approach to stock options.

We suggest a framework which divides grants into five categories:

1. New hires – executives

2. New hires – staff

3. High performers

4. Promotions

5. Retention grants

This chapter details an approach for grants falling into the first four of these categories. Retention grants are covered in chapter 9.

First, we will discuss the principle of granting options to every employee in your team.

Equity for all?

Aligning your team

Should you offer your whole team stock options, or only some individuals? It’s a fundamental question, and one that may come up several times as you grow your business.

The argument for all-employee ownership is simple. It means every hire is invested in your business. It signals that you believe in every employee, and encourages collaboration, and a sense of responsibility. It also means you can address everyone with a single voice – for example, at off-sites and all-hands meetings. Your employees are no longer just employees – they’re co-owners, and this can be a major element of your company culture.

The opposing view, still common in Europe and in late-stage companies, is that many employees prefer tangible benefits – like a bigger salary, pension contributions, health care or a gym membership – to stock options.

Source: Option Impact from Advanced HR (US data), Index European ESOP survey

Unsurprisingly, our research shows that all-employee ownership in Series A/B companies is most common in the Bay Area, at 75%. As you move east, this figure drops, to 32% in continental Europe.

For Series C+ companies, all-employee ownership is less common in the US and UK. This isn’t surprising: the collegiate feel of a startup diminishes as it grows, and the diluting effect of issuing options to all employees can be significant in a large company. Plus, later hires are likely to include more commercial and support staff, who are typically less attracted by equity.

Interestingly, however, continental Europe shows an inverted trend. Later-stage companies are more likely to have an all-employee scheme here than anywhere else. It seems that, in Europe, large companies use equity to foster a sense of community that is otherwise lost as they grow. This certainly chimes with our experience. In fact, we find a majority of European companies introduces (or re-introduces) an all-employee stock option scheme as they look towards a potential IPO.

It’s up to each founder how they approach employee stock options. But we strongly believe making a small grant to every new hire regardless of role, at least up to Series C, can bring huge benefits. Something like 5% of base salary works well. This award would not apply to employees who receive a larger grant as part of their package, such as C-suite employees.

Upfront vs delayed grants

Delayed grants can help you optimise for performance

You also need to decide when employees receive stock options. In the US, they’re almost always part of the offer package. But in Europe, fewer candidates expect them – which gives you more flexibility.

Overall, we recommend being consistent for any particular function. Avoid upfront grants unless there’s a compelling reason to offer them.

In certain roles, new hires will probably expect an option grant upfront. Such grants usually form a major part of compensation for executive hires (C-suite and VP-level), and individuals will almost certainly negotiate this before they join. For these roles, you should always offer the option grant upfront.

Some software developers, if not all, will ask about stock options before they join. Especially if they’ve worked at startups before, or if they’re in a major startup hub. To keep things simple and consistent, we suggest granting all developers upfront options too. Other technical hires, such as product managers and data scientists, may expect the same, but the picture varies more by location.

Holding off on upfront awards for new hires in other functions has one big benefit: you can find out who the real stars are, and compensate them later accordingly. This helps you to hold on to your best people, and keep them motivated. US companies rarely have this luxury – but in Europe, with the likely exception of executives and technical hires as discussed above, you can design a system that truly rewards performance.

We recommend reviewing new hires at 6 or 12 months, and tailoring their equity package based on their performance. Depending on your rate of hiring, you may want to make this an annual or bi-annual exercise for all staff. Later in this chapter, we’ll walk you through a suggested model for both reviewing performance, and for calculating appropriate grant sizes.

Allocation by seniority

Balancing executive and staff equity

Once you’ve secured Series A funding, one of your core challenges will be to scale up. You may bring in new types of talent – particularly ‘go-to-market’ functions (sales, marketing, customer success) and support teams (recruiting, finance, business operations). You’re also likely to make your first executive hires.

This raises a question: how do you allocate options based on seniority?

European companies tend to allocate a high proportion of their stock options to executives – approximately 2⁄3 of the total in late-stage startups. In the US, this ratio is reversed. This reflects the fact that many European employees receive no options at all.

Source: Option Impact from Advanced HR

New Hires – Executive grants

Equity for your C-suite and VPs

Executives include ‘C-suite’ employees and VPs. We recommend calculating executive grants as a percentage of your fully diluted equity (FDE).

Most Series A and B startups have no more than three true non-founding C-level executives – some combination of:

• CTO (Chief Technology Officer)

• CFO (Chief Financial Officer)

• COO (Chief Operating Officer)

• CMO (Chief Marketing Officer) and

• CRO (Chief Revenue Officer)

A grant set at 1% of FDE for each would be typical in both the US and Europe for each of these roles. But there are exceptions, particularly for COOs and CTOs.

COOs

Equity for COOs can reach 1.5% or even 2% — and it can happen as late as Series C. That’s partly because the nature of the role varies hugely from company to company. If you’re hiring a COO, carefully evaluate how complete their skill set is. Are they assuming overall responsibility for the day-to-day running of the business? Do they have proven experience in scaling startups?

CTOs

CTO equity is correlated with a company’s geography and technical DNA. For Series A or B, 1% is typical in the US, and 0.7% in Europe. This reflects the higher pro-portion of tech-enabled business, particularly in e-commerce, in Europe. In the US, there are more pure software businesses, where proprietary technology is the key differentiator.

VPs

VP grants vary widely based on experience, and the importance of their function. As a rule of thumb: 0.3 – 0.8% of FDE at Series A, or 0.2–0.7% at Series B, works well. Product and engineering roles will be at the high end of this scale, whereas HR and Finance will attract smaller grants. VP Sales will also be lower, because commissions are typically a large part of their package.

Following your Series A, you might expect to hire around four executives: three at VP-level, and one at C-suite. As you scale towards Series C+, a team of 6 –10 VP-level executives is typical.

Executives don’t typically receive top-up option grants for high performance. Instead, they negotiate option grants up front, the value of which grows in line with the company valuation.

With the allocations suggested above, you can make a very crude calculation that at a $1 billion valuation upon exit, a C-suite executive with 1% would stand to make $10 million, and a VP executive with 0.3–0.8% would make $3 – 8 million. These figures are before dilution, exercise cost and tax have been taken into account. Nonetheless, this example expresses clearly the scale of the financial opportunity on offer.

New Hires – Staff grants

Options for employees below executive level

We suggest a different method for calculating, and communicating, option grants outside of the executive team. This is because the numbers can be misleading: a 0.05% share of FDE sounds trivial – whereas a grant of $12,500 (the same 0.05% at a $25m valuation) sounds much more compelling.

Instead, your starting point should be base salary. This has two further benefits. Firstly, salary is a reasonable yardstick for the value of each employee. Secondly, it allows you to maintain a standard approach, even with later fundraising. Grant sizes stay the same in cash terms, but the number of options granted automatically declines as the valuation – and therefore share price – increases. This means you offer consistent rewards, but those who joined earliest see the biggest benefit.

After you hit your Series A, you can expect to hire roughly 40 to 50 new staff below the executive level.

We’ve defined three groupings of functions in this table for guidance, based on what we see in the US in terms of option allocation benchmarks. Those in the first group tend to receive the highest allocations, with declining average allocations for the second and third groups. These distinctions can vary considerably from company to company.

Arrange roles into categories to suit your company’s structure. As you scale, you may well create additional groups to become more fine-grained in your allocations. But avoid this when you’re still a small company (under 100 employees). It will make your option plan more complicated both to implement and explain.

Likewise, there are three tiers of seniority defined here, to keep things manageable for smaller companies. Again, as your team grows, you might want to make more detailed distinctions between levels of staff.

In the table above, we’ve used the term ‘Senior’ to define either a highly experienced and capable individual with no people management experience, or someone with slightly less experience, but who is managing a small team. We find that option allocations to these two classes of employees are closely aligned. ‘Individual’ means someone with less experience (perhaps less than five years in a role) and who is not managing other people.

A ‘Director’ heads a functional area, but is not senior enough to be part of the executive team.

Calculating initial grants

Our OptionPlan app will help you

We have developed a 9-box grid to help you calculate grants for employees below executive level – the two axes being seniority, and function.

These percentages are somewhat higher than current European norms. We think they represent good targets for a new startup – but it’s important to remember that there’s no magic number, and may be influenced by the factors identified in chapter 3, related to ESOP size. In any case, the relative award sizes between levels and functions should be a useful guide, even if you choose to adjust them proportionally up or down.

Our OptionPlan tool will also help you to figure out what percentage allocations are right for you.

Visit www.indexventures.com/optionplan

OptionPlan allows you to choose between six different benchmark allocation levels for grants across your team. By customising grant levels and hiring plans, you can quickly test and refine your allocation strategy, and check the impact on your overall ESOP.

Source: Index Ventures recommendation for ‘default’ grant sizes in Europe

What happens if we combine the typical post-Series A hiring plan shown in the previous section, with these stock option allocations by role?

We can apply the $1.6m in aggregate grants across all new hires from the table above, to a notional $25 million post- money Series A valuation. Doing this, we see that they represent 6.4% of FDE. Adding in a typical 4% allocation for employees hired before the Series A, we get to 10.4% of FDE.

This ‘bottom-up’ calculation is 1.6% below our top-down default recommendation for a 12% ESOP for Series A. Which is the situation that you want – giving some room for manoeuvre, in case your hiring plan needs to be stepped up.

Grants for high performers

Index Ventures recommends using its Performance Evaluation Matrix to help you calculate stock options awards related to performance and potential. This applies to any hires who received only the small (5% of salary) option grant upon hire, rather than a full one.

As suggested earlier this might be all hires who are neither executives nor in technical roles.

There are two dimensions: an employee’s performance so far, and how you think they’ll perform in the future. By assessing both on a three-point scale, you can place every employee in a 9-box grid.

The percentage breakdowns are a rough example, based on a typical startup. In this case, around 15% of your staff will be ‘Superstars’ (also classified as gold performers) who contribute highly today and have great long-term potential. Another 15% will be ‘Tomorrow’s stars’ (classified as silver performers), who you believe will add significant value in the future, even if their current performance is merely good.

The percentages are approximate, but should help you avoid a common founder’s pitfall: rating every employee a Superstar. Even if your overall team quality is high, it pays to distinguish the truly great from the good.

You can use the multiplier in each box, together with the base option grant award for each function and level (see page 74), to determine the right grant for each employee.

In some boxes, the multiplier is a range. That’s because, once again, there’s no magic number: you should do what feels right for you and your business. You could set a low multiplier for all ‘bronze’ employees in order to focus on motivating and retaining just your top talent.

Alternatively, you may opt to use the high-ends of our ranges to keep the overall team happier – but you may risk demotivating top performers if they don’t feel like their extra effort is being rewarded.

Promotions

When promoting existing employees, we recommend ‘topping up’ their stock options to match what a new hire would receive in the same role. You could also apply the Performance Evaluation Matrix if they are high-performers, to offer them a larger top-up grant. If their existing unvested stock option grant exceeds this (which is possible for early hires), find a different way to reward them.

Balancing cash and equity

Adjusting to individual risk appetite

Joining a startup isn’t for everyone. It takes a certain type of personality, often combined with a higher appetite for risk.

But a person’s appetite for risk can change. Say an employee needs to secure a mortgage or wants to start a family: cash will become more important to them, even if they remain committed to your company’s mission.

To help, we recommend that you consider a formal cash:equity trade-off policy for new joiners. Job offers will feature a mix of cash and options, but with the chance to increase either one, in a fixed ratio.

You can keep this ratio simple at 1:1. So an individual could ‘give up’ $10,000 of salary in return for $10,000 of additional options. It is important to consider how valuable your equity has proven so far – so if you are seed stage, you may offer a 1:2 ratio, reflecting your higher risk-profile.

Your cash:equity policy should specify limits for a maximum trade-off (for example, 15% of an employee’s salary). Plus, you should clearly state how you’ll calculate future salary increases. An employee sacrificing cash in return for options, which vest over four years, should be eligible for a corresponding salary increase the following year. Or, you may choose to offer the trade-off over consecutive years (see table below).

In Europe, we’ve found risk appetite is generally more variable than in the US. A policy like the one above can therefore be a useful part of compensation negotiations with candidates. Particularly in three scenarios, that we have seen repeatedly.

Poaching from corporates and banks

As you grow, you might need to hire experienced people from corporates in the sector you’re looking to disrupt. In some sectors – particularly finance – existing salaries are likely to be much higher than you will have established in your team.

Realistically, you’ll be talking to a subset of candidates who are willing to take a significant drop in salary to work with you, because they want to be involved in a smaller and more dynamic environment. But stock options are likely to be an important part of the package here. These hires will tend to be much later in your scaling journey, when your valuation will be higher. So you should be able to offer significant grants, without them being hugely dilutive.

Competing with tech giants

Intense competition for technical talent means big hitters like Google and Facebook offer very attractive hiring packages, particularly in engineering, data science, AI and design. It will be almost impossible for you to match the remuneration packages that these companies can offer. Cash:equity trade- off can help you to close the gap, but accept that you will often struggle to win out if a candidate has a competing offer from a tech giant.

Relocating US executives

In a global marketplace, talent moves around. More and more US executives are coming to Europe. And, given the relative immaturity of the European startup market, you may well end up looking for US talent.

But the price can be high. For a US executive, relocation is a risk and a hassle, and compensation is generally higher in the US than Europe.

In each of these three scenarios, a combination of cash:equity trade-off, treating such hires upfront as ‘Gold’ or ‘Silver’ under the Performance Evaluation Matrix, plus the intrinsic appeal of being part of your startup, should help you compete. But we would advise against offering additional benefits to close candidates. Creating a two-tier system can seriously damage morale, and once you’ve started, it’s hard to stop. Know when the incremental benefit of closing ‘that’ key hire is outweighed by the motivational damage you could cause to your team by not treating individuals consistently. It can be a tough, but critical, judgement call.

Worked examples of option allocations

How to apply the rules

The impact of regulation and tax

Founder philosophy, technical DNA, and the maturity of the local startup ecosystem can all have a big impact on a startup’s approach to employee ownership. But on a practical level, the tax and regulatory framework they operate in makes a huge difference, too.

Governments use tax as a lever, and many use it to support entrepreneurs. In the UK, the SEIS scheme offers a 50% tax break for those investing up to £100,000 in early-stage startups, and startups in several countries can use R&D tax credits to offset software engineering costs. As well as helping startups in general, some countries’ tax policies also make employee ownership more attractive.

Which countries are favourable for stock options?

Different countries, different policies

Each country in Europe has its own legal framework and tax code, as well as a unique set of cultural norms. There is no common EU standard. That means the situation needs to be considered country-by-country.

We have reviewed and compared stock option treatment across 20 European countries, plus a further 4 outside of Europe.

To make things simpler, we’ve given each country a score for stock option ‘friendliness’, as well as summarising various rules and regulations. We’ve identified six factors that contribute, scoring each on a five-point scale (5 = the most positive and beneficial).

1. Plan scope

   Can all employees and company types benefit from favourable treatment of stock options?

2. Strike price

   Can options be offered at a strike price below last-round valuation, without adverse tax treatment – reflecting that they are illiquid, high-risk, and non-preferred?

3. Minority shareholders & bureaucracy

   When option holders exercise, they become minority shareholders, who may need to be consulted on various company decisions; does this make stock options unattractive to companies? How does this affect the treatment of leavers? And how much administrative burden and cost is associated with creating and maintaining the plan?

4. Employee tax (timing)

   Are employees taxed only when they sell shares, or when they exercise – or even at the point of grant?

5. Employee tax (rate)

   Which rate is applied – income, capital gains, or something else? Are employee social contributions payable, and if so, how much are they?

6. Employer taxation

   Is there any financial impact for companies using stock options? If so, when is it incurred? What rate is applied? Are employer social contributions payable, and if so, how much?

We’ve done our best to provide correct and current information, but you should do your own research, and take legal, tax and investor advice. The best approach for your company may be influenced by other factors beyond the scope of this handbook.

When are employees taxed?

This is a critical factor impacting the attractiveness of stock options. The later they are taxed, the better. Not only for the employee – but in our opinion, also for governments, because tax-receipts are maximised by targeting the point of greatest financial upside.

There are four points at which stock options may be taxed:

1. Grant

   A few countries treat the issue of options as a taxable benefit, with tax based on the fair market value of those shares. This is a strong disincentive for both employers and employees.

2. Vesting

   Some countries tax option holders when their options vest, even if they don’t exercise immediately. However, this is more common with other equity-based incentives (for example, RSUs) than with stock options.

3. Exercise

   Many countries tax employees when they exercise options and buy shares. Tax is applied to the spread between strike price and fair market value at the time of exercise, and is treated as income (rather than a capital gain).

4. Sale

   Almost all countries tax employees when they sell their shares, but the tax rate applied varies. Some countries treat the profits as income; others, as a capital gain.

In practice, exercise (3) and sale (4) often happen simultaneously. This is important because employees may have to pay higher income tax rates attached to exercise, than lower tax rates attached to sale. The two most common circumstances where this could happen are:

• Employees with vested options, when the company exits through a trade sale (this is much more common than exit through IPO).

• Former employees with vested options, where the company has a policy where leavers retain options, but cannot exercise until an exit (this is common in Europe as we saw in chapter 4).

Our analysis

In our analysis, countries fell into four groups. Unsurprisingly, practice mirrored policy – companies operating in ’friendlier’ countries were more likely to have all-employee option schemes.

Winners

The Baltic States, Israel, Canada

These countries have policies which strongly support the use of stock options by startups: at all stages of growth, and for all levels of employee. Programmes are simple to implement, with minimal cost to companies. Strike prices can be heavily discounted from previous-round valuations, applying US 409A valuations or better. Employee taxation is deferred to the point of sale, and taxation on upside is 25% at most.

These countries scored between 27 and 30, out of the maximum score of 30.

High ranking

France, UK, Portugal, USA

These countries have implemented programmes to support the use of stock options and similar schemes to reward startup employees.

They adopt at least two of the following policies: deferring when tax is payable; reducing the effective tax rate on sale; allowing strike prices significantly below previous-round valuations, and reducing the burden on companies to pay tax or social charges on stock option awards.

These countries all scored 24 to 26.

The UK government’s EMI scheme, first introduced in 2000, is particularly worthy of mention. It has created one of the most startup-friendly environments in the world, and has undoubtedly contributed to the county’s leading position in Europe.

However, the scheme is showing its limitations. The maturing London ecosystem now has at least 50 tech startups which have exceeded the company size criteria for EMI (including 250 employee limit). These companies are being forced to adopt much less employee-friendly approaches, damaging their ability to effectively reward talent. Policymakers are advised to broaden the scope of the EMI scheme, to protect the UK’s advantage in European tech.

Runners-up

Poland, Italy, Sweden, Ireland

These countries scored between 20 and 23 points in our analysis. They have implemented specific policies to support the use of stock options and similar incentives for startup employees. They defer taxation to the point of sale, and apply capital gains tax rates instead of income tax.

The main problem with these schemes is their scope – they are not available to all startups. They often only apply at very early-stage. Once a company outgrows the scheme, the alternatives become much less attractive.

We hope to see the scope of these schemes extended in the years ahead, by forward-thinking governments. Encouragingly, in October 2018, the Irish government proposed to broaden its KEEP programme to allow for larger employee option grants.

Ripe for change

Australia, Denmark, Netherlands, Switzerland, Norway, Czech Republic, Finland, Austria, Spain, Germany, Belgium

These eleven countries scored 16 or lower, placing them at the bottom of our grid. Most lack any specific programmes supporting stock options; administrative barriers make the use of stock options a serious headache for companies, even where there is a specific programme.

Even so, startups often do use stock options or similar instruments anyway. They often prevent employees from being able to exercise vested options until a change of control. This avoids the complexities of having minority shareholders on the cap table.

Alternatively, startups (particularly in Germany, Spain, Austria, and the Czech Republic) have resorted to offering ‘virtual options’, which mimic stock options, but don’t offer ownership in the same way. These are simple to implement and administer, and avoid some of the tax burden. But there are disadvantages.

Unlike real stock options, VSOPs are generally structured as an employee benefit, which companies can choose to remove without-cause. Leavers often forfeit all rights to virtual options. These differences make savvy hires sceptical. Because of this, virtual options don’t bring the same benefits in terms of attracting and retaining talent.

We encourage startups using VSOPs in these countries to allow employees to ‘exercise’ or retain vested virtual options if they leave the company.

But we also encourage governments to change policy and make ‘real’ stock option schemes more viable. Whilst virtual option schemes may mirror some of the economic benefits of real stock options, they are conceptually very different – employees cannot truly be considered ‘owners’ if they hold virtual options.

The policy priority for these countries is to reduce tax rates for stock options, which is often in excess of 50% (including social contributions) for employees, and 20% for companies. This should be followed up with moves to defer employee taxation to the point of sale rather than exercise.

Such changes would create more ‘winners’ amongst employees at successful startups. These individuals would then act as advocates, drawing more top talent into these startup ecosystems.

The Belgian challenge

Belgium ranked lowest amongst all the countries that we reviewed, with a score of 10 out of 30. Employees are hit with a tax at the moment they accept an option grant – currently 18% (sometimes discounted to 9%) of the stock’s assumed value. Consequently, Belgian startups issue few stock options.

Take-aways

Across Europe and the rest of the world, approaches vary widely. Several countries are in fact at least as ‘friendly’ as the US. In Europe, these include Latvia, Estonia, France, the UK, and Portugal. A few European governments are experimenting with startup-friendly policies, including Sweden, Italy, and Ireland.

These need to be bolder. Other countries, including Germany and Belgium, lag further behind with no specific schemes to support startups.

Policies drive practice. The onus is on policymakers to work with entrepreneurs, and foster a better environment for both startups and talent.

Options without borders?

Don’t get hung up on parity

As your company becomes more successful, you’re likely to expand beyond your HQ country. Whether you’re setting up offshore engineering centres or sales and marketing outposts, you’ll need to hire international employees.

This raises some questions:

1. Do these hires get grant options?

2. If so, do you use your existing option plan, or a separate one to suit the local market?

3. What methodology should you use to calculate any grants?

Culturally, you may feel all your employees should be treated the same, regardless of where they are. This is a great starting position, however it’s not always clear what it means. Spending power, taxation, and other benefits such as vacation allowance, healthcare and pensions can – and will – vary considerably from country to country. So don’t get too hung up on equalising your stock option offers between countries.

On the practical side, regulation and tax requirements around granting options vary considerably between countries. So adapting your ESOP approach may be in everyone’s interest.

Specialised legal advice on making local ESOP arrangements can be costly and time-consuming. If possible, delay setting up a local scheme until you’re confident that you’re going to stay in a particular location.

To help you navigate each market, we’ve laid out the most common expansions in this table:

Single or multiple valuations?

Option strike prices can be more advantageous in some markets than in others. An advantageous strike price increases the benefit to your employees of a given grant, and means each of your options ‘work harder’. Obtaining discounted strike prices involves getting locally approved valuations, which can be messy: options will be worth different amounts in different places.

The important thing is to make sure you’ve provided the same inputs for valuation in each country. These may be revenue forecasts or performance metrics. You also need to be consistent with exchange rates, to avoid accounting gymnastics.

The US and UK are the two major markets where you may benefit from discounted strike prices, which are pre- approved by tax authorities. The UK often allows lower fair market valuations (which determine your strike price) than in the US. However, if you expand significantly into the US, you will probably end up applying a US valuation, also known as a 409A, to avoid complexity.

Some European startups apply the 409A valuation methodology to strike prices they use in certain other countries. This can work, but carries the risk that local tax authorities challenge it at a later point. The tax consequences of this can be very significant. We advise specialist legal advice, and consultation with other founders.

Moving people between countries

It’s best to ask a lawyer

If an employee takes up a new role in your company in a different country, tax and legal issues can get complicated. Seek legal advice to avoid nasty surprises. You should also contribute towards the employee’s legal costs.

So far we’ve looked at a typical Series A startup, with a headcount under 100, a simple organisational structure and no employees of more than three years’ tenure.

Of course, every company is different – but as you scale, things will get complicated. In this chapter, we’ll explore some common challenges, and how to navigate them.

Growing headcount

More levels means more complexity

As your company grows, you’ll be adding new functions and levels of seniority. Calculating equity rewards will become more complex. We’ve worked with later- stage companies with over 20 different employee functions in their stock option allocation matrix.

Growth may affect your company’s eligibility for specific types of employee ownership programmes within your country. Again, make sure your lawyers keep track of any cliff-edges that might trigger a change in how you award options.

For example, if you’ve set up an EMI scheme in the UK, be aware of the ceiling limits. You will not be able to benefit once you’ve hit the 250 global employees mark, for instance, and will need to explore the various UK schemes more appropriate to later-stage. These are outlined in the UK country table on page 106.

When do RSUs make more sense?

In recent years, late-stage startups have been taking private funding at extremely high valuations, rather than heading straight for an IPO. Facebook set this trend; Uber, AirBnB, Pinterest, and now many others followed. Faced with high strike prices and less valuation upside, stock options become a much less compelling tool for retaining top talent. Particularly when grants exceed ISO limits and so lose their tax advantages.

In these conditions, US ‘unicorns’ have shifted to RSUs, an instrument previously used only by public tech companies. RSUs don’t have a strike price – instead, they convert directly into shares over the vesting period, with income taxes due at the point of vesting. To avoid painful tax bills, private companies usually adopt a special rule, which delays any vesting to coincide with an exit event.

Retention grants and programmes

How to hold on to your stars

Other companies will inevitably try to poach your staff – especially if you’re successful. Earlier-stage startups are particularly fond of hiring people from more scaled-up businesses. A generous offer from a rival startup can look all the more appealing to an employee when their stock options are coming to the end of their four-year vesting period.

You want your best employees to stay put. Equity retention programmes can help. These are also sometimes called ‘refresher’ or ‘top-up’ option grants.

Who needs a refresher, and when?

Retention grants can be a great tool for employees approaching the end of their vesting schedules. You can do this on an ad hoc basis, but by Series B or C, we recommend you establish a more formal approach.

Even in Silicon Valley, ad hoc retention grants are more common than structured plans, though more mature companies are more likely to have one. In Europe, only 42% of startups have any kind of refreshers, ad hoc or otherwise.

Andy Rachleff of Wealthfront – an asset management startup, and member of the Index portfolio – has set the bar for retention programmes in Silicon Valley.

Under his approach:

• All employees are granted annual refreshers, starting 2.5 years after their original option grant.

• The refresher is equal to a quarter of what the employee might expect to receive if hired for their position today.

It’s worth reading Andy’s blog post, The Wealthfront Equity Plan, outlining his approach, and the benefits he has seen as a result.

European retention grants

Whilst Wealthfront’s approach is a great starting-point for developing your refresher programme, we recommend that you adjust it for a European context.

Which employees should receive additional stock options? We suggest you look to your highest performers, as determined by using the performance grid we introduced in chapter 6.

You might decide to offer refreshers to your Gold performers only – about 15% of your employees – or you could also include Silver performers – meaning they apply to about 50%. We rarely see situations where it makes sense to offer retention grants to more than 50% of employees: You would usually be better off applying larger retention grants to your key individuals.

It makes sense to disclose retention grants to employees once they are between 2.5 and 3 years into the vesting of their previous grant. Knowing they can look forward to a new grant will act as a deterrent against ‘wandering eyes’ before individuals reach their final year of vesting.

However, we suggest timing the cliff for the new grant to coincide with the completion of vesting of the individual’s previous grant. Vesting on the new grant should only start at that point. This is unlike the stock option awards we have discussed up to now, which start vesting as soon as they are granted.

This approach avoids employees with multiple grants vesting simultaneously. Not only is this more dilutive for the company, it can also be more confusing for the individual. There is no point in awarding stock options if an individual doesn’t understand what they are getting.

Rather than making annual retention grants, we recommend a single new four- year grant. This reduces complexity, and allows employees to benefit from a strike price based on a valuation earlier in time.

Size of retention awards

We recommend calculating retention grants as if you were hiring the employee now, into their current role. You can therefore apply the 9-box grid that we presented earlier for determining the grant as a percentage of current salary.

This approach means that the individual is being awarded in line with any newer employees who are their peers, which ensures consistency and fairness.

Retaining early joiners

For team members who joined early, even a generous refresher may feel small compared to their initial grant – because your valuation can be so much higher. An illustration of this challenge is shown below.

In this example, a senior engineer who received an initial $50k option grant at seed stage is being considered for a refresher after Series B. However, an appropriate grant at this stage for this role might be worth another $50k.You would need to offer a retention grant of $320,00 (6.4x the size of the individual’s initial seed-stage grant), for it to have as much potential upside. The question needs to be asked whether this is the most effective use of precious equity, as opposed to using that equity to hire and motivate an experienced new hire?

You might have to be more creative in coming up with incentives, financial or otherwise, for these early joiners. Offering the opportunity to sell down some existing shares over time in a secondary offering is one alternative that has proven to be effective.

Secondary sales

Giving back to loyal employees

In 2000, the average time from formation to IPO was just six years. Now it’s eleven, according to the McKinsey report ‘Grow fast or die slow’. Unless there is an opportunity for secondary sales, employees can be waiting a very long time before they receive any financial benefit from their options, and become demotivated as a result.

Secondary sales offer investors the chance to buy stock from existing stockholders, instead of buying newly issued shares. It has traditionally enabled early angel or seed investors to ‘cash in’ and exit a company.

In recent years, secondary stock purchase mechanisms for employee equity have become more established in the US. Usually, purchases are part of a fundraising drive, with secondary stock sold at a 15% discount compared to newly issued shares. Early employees with fully vested grants can be included in secondary purchases.

All early employees should be included to avoid favouritism, but we’d recommend capping the amount employees can sell at 15–20% of their total vested options. This makes sure there’s still a retention benefit to their remaining options.

You might also set a limit to the amount of cash any single employee can earn from a secondary sale (e.g. $250,000), with a simple pro rata mechanism if options supply exceeds investor demand. This reduces the risk of employees sailing into the sunset, having already received a life-changing sum of money.

Secondary sales are only viable if you have high investor demand for your equity. But they can be a terrific motivator, and not only for the employees who benefit directly from them. They are tangible evidence to everyone else in the team that their stock options have real monetary value, and should be celebrated as openly as possible. They act as a ‘force-multiplier’ over all the stock options that you have issued.

Secondary markets have also emerged as a way to create liquidity for employees. Such markets received bad press in 2012, when pre-IPO Facebook stock changed hands at dramatically varying prices, with little oversight. This led to some describing secondary markets as a ‘Wild West’.

Since then, companies have put in place methods to make sure secondary trades do not take place through back channels. For example, some ensure a right of first refusal, which gives existing investors the first opportunity to purchase shares – and retain control of the company.

Others now operate an annual programme. Vested employees are invited to offer options for purchase by pre-approved outside investors, often through an independent tender. This means fewer secondaries now take place through brokers or marketplaces.

It’s still early days for these new methods in the US, so it’s likely to be some years before we see them emerge in Europe.

Strategic advisors

So far, we have exclusively discussed employee stock options. However, the contribution of advisors, independent directors, and chairperson can also be critical. This section provides guidance on incentivising and remunerating these positions.

Time – Reputation Matrix

Two dimensions can be used to evaluate individuals in these roles. The first reflects time commitment. This not only reflects attendance at formal company meetings. It also includes preparation time, pre- briefing and de-briefing calls, answering ad hoc questions and concerns, helping to close candidates, customers or partners, and much else.

The second dimension relates to reputation. The more well-known and respected someone is in your sector, the more valuable they are to you. The ‘brand halo’ of their involvement can validate your company’s legitimacy and credibility. The more public their involvement with your company, the more they risk their personal brand equity. And opening their network for you can amplify the contribution they can make.

Remuneration should reflect these two core dimensions. A highly-committed and highly-respected advisor should be remunerated at the top of your range. At early stage, reputation can often – but not always – be more valuable than time-commitment. As you mature and establish your own brand equity, time-commitment may become more important.

The equity benchmark averages provided in the following pages mask differences across these two dimensions. This explains the wide range of awards. You will need to assess where a given individual is positioned across each.

When looking at remuneration for these roles, a marked distinction emerges between startups in the US and Europe. In the US, they rarely involve cash, with incentives entirely in the form of stock options (or RSUs). In Europe, it is much more common to see a mix of cash and equity.

There are often country-specific restrictions on what equity instruments you are allowed to offer to non-employees, and tax-advantaged schemes are almost always restricted to employees. You need to take specific legal advice.

You may be advised to use standard stock options, RSUs, or warrants. The individual should seek their own tax advice as they may well have a complex personal tax situation, which you do not want to second guess.

Advisors

There is no set job description for an advisor. Each relationship will be bespoke. You may have an advisory council – for example, a health startup seeking input and validation from the medical world. Or advisors may be specific to particular functions – for example, a technical advisor who is part-mentor to your CTO, and part-strategist advising your board.

Advisors can get involved with a startup at any stage of its life. At seed stage, advisors may also be angel investors. As you scale, advisors are more likely to be specialists, with a narrower brief.

As discussed earlier, time commitment can vary considerably, but a typical advisor might commit to two days per month.

Advisor equity as a percentage of FDE is higher at seed stage, averaging 0.7% in the US.This drops to 0.3–0.4% for advisors at later stages, but increasing in terms of grant value.

In Europe, advisors are more likely to expect a cash component, for example in the form of a day-rate. Cash may be more important if the advisor is making a heavy time-commitment supporting you. Cash is often less important if the advisor has a high-profile reputation. This is unsurprising – reputation tends to correlate with wealth: a wealthy advisor will be less interested in day-rate and more interested in the long-term potential value of their equity.

In cases where a high-reputation advisor expects a day-rate payment, a typical arrangement might be €1,000 per day plus 0.2% equity (at Series A or B).

Independent Directors

It is rare to appoint any independent directors before Series B. Unlike advisors, the role has a specific set of fiduciary responsibilities, with a level of personal liability. As a result, their time commitment may be lower than advisors (1–1.5 days per month is typical), but with comparable levels of equity remuneration.

Once again, in Europe there is more likely to be a cash component to remuneration, averaging €31– 40k per year, with a corresponding reduction in equity offered.

Equity for independent directors (and Chairs), whether in the form of stock options or RSUs, tends to vest over two years, rather than the standard four. This is because the roles are less secure. For tax reasons, options usually have a strike-price based on last-round valuation.

Chair

Like independent directors, a chairperson is rarely appointed before Series C. The role carries significant fiduciary responsibility and personal liability, and involves a higher time–commitment (average 4 days per month). Chairs will almost always have a prominent reputation in your sector, and a deep network which they should leverage on your behalf.

In the US, equity grants for Chairs average 0.85% at Series B or C, with a range of 0.5% to 2.0%. In Europe, once again, there is sometimes a cash element, with lower equity.

ESOP admin and tracking

How to stay on top of the paperwork

Running an ESOP involves a serious amount of paperwork. You’ll need to keep track of all employee start dates, salaries and allocations, alongside the total number of shares in your company and your share price.

As your team grows, the size, dates and strike prices for every new grant should be carefully monitored. You’ll also start to model out allocated and unallocated elements of your ESOP, and projected grants for future hires. New option grants will need to be approved by your board and formally registered with relevant authorities.

Tip 1:

Avoid endless board meetings. Get approval for your standard allocation grid for option grants, so you won’t have to discuss every award. Only exceptions to your approach (and awards to executives) will need further board discussion.

Tip 2:

We also recommend a pro forma approach to tabling option grants, to make sure you’re giving board members all the information they need.

Separate this table according to Reason for the grant – new hire, high performer, promotion, or refresher. Include a separate table, summarising your ESOP and FDE position before and after:

You should work with a lawyer to make sure that all registrations and returns associated with your ESOP and grants are professional and above-board, with a full audit trail for future reference. We’ve seen grants that weren’t lodged properly with tax authorities become invalid years later, causing real financial and emotional pain. Later-stage investors will also expect to see thorough record-keeping as part of their due diligence processes.

In Europe, grants are generally approved and lodged annually or bi-annually to minimise administrative overhead.

Employee ownership is a sensitive area. Founders generally keep control of the process, data and administration, until they can delegate to a suitable senior finance or HR leader. So at least until you appoint a CFO, you’ll be holding the pen.

This can be quite overwhelming: 57% of respondents in our survey said their option plans take up ‘quite a lot’ or ‘loads’ of their management time.

Source: Index European ESOP survey

Even the most sophisticated spreadsheet will struggle to contain all your data when your team grows beyond 200+ employees.

A lot of our early-stage companies in the US, and increasingly also in Europe, use Carta, a software tool specifically designed for cap table management, including option grants for VC-backed startups. It maintains a full history of grants made, with a self-service portal for employees to check their grant details.

Later-stage companies, with more complex, global corporate structures, and preparing for IPO, often adopt enterprise cap table management solutions, such as Shareworks from Solium.

However much time and effort you put into crafting your stock option plan, employees may not understand it. This is a common problem – and it can be frustrating.

How you communicate your plan matters almost as much as the plan itself. Get it right, and your employees will understand the plan, and make the most of it.

Everyone wins.

Clarity matters

Your plan needs to make sense to everyone

Stock options can be attractive – and valuable – assets for employees. But they’re also difficult to understand, particularly for people who aren’t familiar with financial jargon and small print.

Your basic assumption should be that your employees don’t know anything about options. Accept that not everybody will read every bullet point and footnote; at best, many employees will just skim the key information and move on.

So clarity matters. You may even choose to adapt your message for different groups, with varying levels of expertise and interest.

Source: Index European ESOP survey

Misconceptions

Employees with limited knowledge aren’t the only potential problem. You might find some employees have misconceptions about how stock options work. For example, they can have unrealistic expectations of how much you should grant them.

Conversely, some employees won’t realise that options involve no risk on their part – they may expect an upfront payment required to ‘buy’ their options, and therefore they won’t read any further.

Communication dos and don’ts

Give employees a clear summary, and help them understand risk

It’s important to spell out your option plan clearly, without any room for misunderstanding or confusion. From day one, your message should be the same for every employee (there are some exceptions to this on the right).

Best practice: dos and don’ts for communicating option grants

Segmenting your audience

There’s no one-size-fits-all approach

We recommend adapting your communication based on the different types of grants you’ll make.

• Small grants for all new hires

• Grants for new executives

• Grants for high performers or upon promotion

For each type of grant, you need to think about:

• Transparency

  You need to decide what is the right level of information to give employees, particularly around ESOP terms.

• Managing expectations

  You want your employees to get excited about their grant, without building up unrealistic expectations. Be clear about strike price. You might also share the history of your share price. This allows you to present a maximum of three future scenarios, based on different outcomes, and what this means financially.

• Written and verbal communication

  You might find a face-to-face chat the best way to illustrate value potential. Handing out spreadsheets with phrases like ‘value at exit’ can lead to confusion

• Who, how and when

  You need to decide which member of your team communicates grants – and be clear about the process they should follow. In larger companies, managers, and the entire people function, need to be trained to a solid level of understanding. That should be able to clearly answer the majority of questions that arise from employees. Legal and finance teams should be asked to address more complex questions.

Small grants for all new hires

Giving a new employee a small option grant shows them the importance in your company culture of collective involvement and shared goals. Plus, it will make them feel good about their new job.

A small option grant is primarily symbolic, so there’s no need to get into the details. Tell your employee that there’s no risk associated – and that if the company is successful, their grant might turn into a nice cash bonus in a few years. But be clear that this grant isn’t going to make them a millionaire.

Until you’ve reached around 50 employees, try to have this conversation 1:1 with new hires. After that, it could be done in onboarding cohorts, with an offer to follow-up 1:1 upon request.

Grants for new executives

Incoming executives will expect more detail about their grant before they join, and maybe about your ESOP rules.

It’s worth taking time to talk through the current valuation of the company and your hopes for future potential valuation.

Be straightforward about dilution – but unless you’re asked, you don’t need to go into too much detail (for example, by explaining layered prefs in the cap table).

You can decide whether to discuss change of control or leaver provisions. It may be easiest to refer them to your ESOP plan, but be ready to answer any questions.

Grants for high performers or upon promotion

Grants tell high performers and promoted employees that they’re valued. They help retain and motivate – and make individuals feel like they’re a key part of your future.

It’s a special level of recognition, and should be treated that way.

Awards should be communicated in person, by your CEO or another relevant member of the executive team. The grant letter can be handed over during the meeting, as you emphasise how the employee fits into your ambitions for the coming years. Offer a follow-up meeting with the CFO for any questions they might have.

This handbook has brought together benchmarks from the US and Europe around employee ownership for the first time. We hope it’s given you more clarity – and provided actionable and practical recommendations for your company stock option scheme. Our research into employee ownership and stock options at Index Ventures is ongoing and we will continue to expand and update our data.

Employee ownership will become an ever more pertinent subject as competition for talent gets fiercer and more global. Let’s keep the conversation going – among founders, investors and employees.

Sparking debate

Regulation and tax practices vary massively across Europe – from some of the world’s most favourable schemes for startups, to some of the most unhelpful. If the European tech ecosystem is to grow and thrive, it is our belief that entrepreneurs and government bodies need to work collaboratively. We need to address the barriers that taxation and bureaucracy pose to innovation and job creation.

It is for this reason that in early 2019, Index Ventures helped to launch the #NotOptional campaign, with an open letter to European policymakers signed by over 700 of Europe's leading entrepreneurs and investors. The campaign is already yielding results through engagement with the European Commission and national governments. We will continue to push for a 'levelling up' of the European playing field on behalf startups and startup employees.

Your next step

Try our OptionPlan tool. We’ve made it simple to test and refine your allocation strategy against various benchmark levels – at both seed stage and Series A – and to check the impact on your overall ESOP size.

Are you thinking about trialling an innovative approach to employee ownership and stock options at your startup?

If so, we’d love to hear from you. Reach out to Dominic Jacquesson at Index Ventures (talent@indexventures.com).

Glossary

Cap table

List of all company shareholders, the number of shares, class and percentage of shares they hold.

Change of control

When ownership of a company shifts such that control moves from one party (or parties) to another. For example, when the company is acquired, or goes public. But it can include an investor obtaining more than 50% of the shares.

Cliff

Non-vesting period after options have been granted.

Dilution

When existing shareholders’ equity share shrinks as new shares are issued, usually through fundraising. Dilution also affects stock option holders.

ESOP

Employee Stock Option Plan – the legal framework for giving options employees. The ESOP also lays out the standard terms and provisions for stock option grants by the company.

FDE

Fully diluted equity – the total number of issued shares, plus stock outstanding options, in your cap table.

FMV

Fair market valuation – an appraisal of the value of your company’s common stock. With publicly traded stock it’s easy to check real-time value. For private companies, you need an independent valuation. This might be significantly lower than what a professional investor would be willing to pay, for various reasons including illiquidity, and the fact that investor shares are usually prefs not ordinary. A defensible FMV is important if you are later challenged by tax authorities for offering shares or options at a discount, which could be seen as tax avoidance.

Post-money valuation

Company’s valuation after fundraising. Pre-money valuation + total amount of new funding raised.

Pre-money valuation

Valuation before fundraising – reflects what investors are willing to pay for shares in the company at that point in time.

RSUs

Restricted stock units are a promise to issue common stock at zero cost in the future to the holder. Whilst stock options are issued early in the life of a startup, RSUs tend to be used by public companies, or sometimes by late-stage private companies. Shares are delivered automatically on vesting. There is no exercise process.

Share capital

Total individual shares your company can issue.

Share price

The total valuation, divided by the total number of shares. The fully diluted share price is the valuation, divided by the sum of all shares and share options in the ESOP, whether or not they have been allocated yet.

Stock option

A right (but not an obligation) to purchase a given quantity of shares at a set price for a fixed period (usually 10 years).

Strike price

Fixed price for a given option grant – the amount an employee must pay to buy each share. It is also referred to as the exercise price or option price.

Vesting schedule

The timeline over which options become exercisable, or, the point at which they can actually buy shares. Unvested options are normally cancelled and returned to the unallocated ESOP pool when an employee leaves the company.

Company profiles

Carta

Carta is the first and only SEC-registered Transfer Agent for private companies. Their online platform allows companies – from seed stage to pre-IPO – to manage equity electronically with the participation of shareholders, employees, auditors, and legal counsel.

Criteo

Criteo is the global leader in digital performance display advertising, partnering with over 3,000 international advertisers to deliver highly-targeted campaigns.

Elastic

Elastic is the company behind the Elastic Stack — that’s Elasticsearch, Kibana, Beats, and Logstash. From stock quotes to Twitter streams, Apache logs to WordPress blogs, they help people explore and analyse their data differently using the power of search.

Farfetch

Farfetch is the global platform for luxury fashion, connecting customers in over 190 countries with an unparalleled offering from the world’s best boutiques and brands from over 40 countries.

Just Eat

Just Eat has reinvented the takeaway. From keystroke to doorstep, the London- headquartered company has built a seamless multi-platform service, with more than 74,500 restaurant partners on its roster, covering 13 countries from Scandinavia to Latin America.

King

Creator of Candy Crush Saga, Farm Heroes Saga, Pet Rescue Saga and Bubble Witch Saga, King is the worldwide leader in casual games with more than 30 billion game rounds played per month globally, as of Q2 2017.

Mimecast

Mimecast is a category-defining SaaS company for unified email management, safeguarding email security, archiving and seamless continuity.

The Family

Moving at startup speed, The Family transforms portfolio startups, special projects and virtual infrastructures into a highly connected community of entrepreneurs, operators and fellow investors.

Wealthfront

Wealthfront fuses world-class financial expertise with next generation technology to provide access to the same high quality financial advice offered by major institutions and private wealth managers, without the high account minimums or costs.

Thank you

We would like to give special thanks to Advanced HR, Taylor Wessing and Seedcamp for providing expertise, content and data.

New ideas in compensation data and design for private, venture-backed companies. Advanced-HR provides compensation data to more than 2,300 private companies through Option Impact and partners with 115 leading venture firms to produce the VC Executive Compensation Survey. They also launched Option Driver – a revolutionary platform that enables startups to get and keep the right people.

Certain individuals provided us with particular assistance including:

Clint Smith, Florent Artaud and Alexandre Leger Cattarini.

Taylor Wessing is a full-service international law firm, working with clients in the world’s most dynamic industries. We take a single minded approach to advising our clients, helping them succeed by thinking innovatively about their business issues.

Seedcamp is Europe’s seed fund, identifying and investing early in world- class founders attacking large, global markets and solving real problems using technology. Since launch a decade ago Seedcamp has invested in 250 startups including fintech unicorn TransferWise.

Contributing startups

Amir Mizroch

Director Of Communications, Start-Up Nation Central

Abakar Saidov

Co-Founder & CEO, Beamery

Alex Gayer

CFO, Swiftkey (former)

Alex Wakeford

Finance Director, Secret Escapes

Alexandre Leger Cattarini

Founder & CEO, Equify

Andy Rachleff

Co-Founder & CTO, Wealthfront

Anna Fredrixon

Head of HR, KRY

Ben Medlock

Co-Founder & CTO, SwiftKey

Benjamin Smith

Finance Director, MOO

Benoit Grouchko

Co-Founder & CEO, Teemo

Beth Clutterbuck

VP Global Head of People, Deliveroo

Carlos Eduardo Espinal

Managing Partner, Seedcamp

Chloe Palmer

HR Director, Secret Escapes

Christine Cordon

General Counsel, Secret Escapes (former)

Clint Smith

SVP Corporate Development & General Counsel, DataStax

Corey Harrower

Chief People Officer, ROLI

Daniel Ghilea

Freelance Developer

David Booth

Product Lead – International, Carta (former)

David Okuniev

Co-Founder & Co-CEO, Typeform

Dee DiPietro

CEO, Advanced-HR (former)

Diego Rivas

Product Manager, Curve

Douglas Squirrel

Director, Squirrel Squared

Dr. Frank Freund

Co-Founder & CFO, Raisin

Dr. Stefan Hesse

CFO & UK Managing Director, Alkemics

Edouard Peers

General Counsel, onefinestay

Ellen Tukk

Stock Options Manager, TransferWise

Emma Phillips

Operations Director, LocalGlobe

Eric Klotz

Legal Counsel, CallidusCloud

Erik Byrenius

Founder, StartupDocs

Fiona Russell

General Counsel, Betfair (former)

Florent Artaud

CEO, Ekwity

George Henry de Frahan

Partner, LocalGlobe

Helina Meos

Employment Tax Manager, TransferWise

Henry Ward

Founder & CEO, Carta

Huw Slater

CFO, Typeform

Ingo Uytdehaage

CFO, Adyen

James Meli

Practice Leader, LegalVision

Jay Orsborn

VP Finance, Culture Amp

Jean Baptiste Rudelle

Co-Founder & CEO, Criteo

Jean Daniel Guyot

Co-Founder & CEO, Capitaine Train (former)

Jeff Eneberi

General Counsel, Just Eat (former)

Jen Swallow

General Counsel, TransferWise

Jill McKnight

Practice Leader, LegalVision

Jon Bradford

Founding Partner, Motive Partners

Josh Jian

Head of Finance & Corporate Development, Credit Benchmark

Julian Fichter

Project Manager, People Analytics, SoundCloud (former)

Juliet Russell

Head of HR, MyOptique

Kasper Heine

General Counsel, Trustpilot

Lachlan McKnight

CEO, LegalVision

Leah Sutton

VP, Global HR, Elastic

Lee Greening

Finance Director, FaceIT

Lucy Vernall

General Counsel, Funding Circle

Marc Strigel

COO, SoundCloud (former)

Markus Haider

Finance Director, SoundCloud (former)

Mike Wroe

CFO, Just Eat (former)

Neil Miller

General Counsel, SoundCloud (former)

Olda Muller

CFO, Socialbakers (former)

Oussama Ammar

Co-Founder, The Family

Oren Barzilai

Founder & CEO, EquityBee

Oskar Arndt

General Counsel, iZettle

Patrick Foster

Chief Business Development Officer, Drivy

Peter Campbell

CFO, Mimecast

Philipp Moehring

Europe, AngelList

Ray Raff

CEP – FP&A, Carta

Reshma Sohoni

Co-Founder & Managing Partner, Seedcamp

Rob Miller

Chief Legal Officer, Deliveroo

Sam Harper

General Counsel, Deliveroo (former)

Sean Nolan

Founder and CEO, Blink

Sian Keane

Chief People Officer, Farfetch

Simon Baldeyrou

COO, Drivy

Smadar Levi

CFO, MyHeritage

Stephane Kurgan

COO, King

Steve Domin

Co-Founder & CEO, Duffel

Tim Vandecasteele

Co-Founder, Silverfin

Tom Rippon

Freelance Developer

Valentina Milanova

Founder & CEO, Daye

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indexventures.com

Copyright 2018 by Index Ventures. All rights reserved.

Contributions and insights from the Index Ventures Investment and Legal teams.

Researched and written by Dominic Jacquesson, Director of Talent at Index Ventures.

The information provided in this handbook, in particular chapter 7, is a general guide and specific legal and tax advice should be sought when implementing option arrangements.