After doing dozens of interviews, we felt that most of the interviewees were not familiar with the topic of stock options. As they do work very differently across countries, we want to explain the concept and try to define the most important terms in the German market, so you can make up your own mind.
<aside> 📖 Stock Options = The right to participate in a future exit
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Stock options (or something similar) are used by many startups for compensating their employees. They grant the right to participate in the upside of an exit event like an IPO, sale or trade sale when the company turns out to be a massive success.
Most German startups do this using a virtual stock options program. This is the most convenient form, leaving employees with so-called phantom shares. They mimic proper shares in certain aspects, but are no real shares, meaning the employee is no direct shareholder of the company (which can get quite extensive having >100 people). Therefore, the employee gets the right to participate in the exit event. To make sure this works out the founders and investors devote a certain threshold of the real shares to cover this.
To be completely honest there is no guarantee that everything will turn out as planned, so there is the risk that the stock options will lose their value (similar to the risk that a stock can perform bad).
Employee stock options program (ESOP): A program that sets out the terms of employee equity.
Employee Stock Options (ESOs): Offer the holder the right (not the obligation) to buy company shares at a predetermined price over a specific timeframe. ****
Virtual shares (VSPs): A contractual right for the employee that mimics an ESO without the real option
The difference between ESOs and VSPs: Virtual share options are more tax efficient, because tax has to be paid with realization of the gains, therefore they only mimic the actual shares, meaning that no voting rights come along with them. VSPs are way easier in administration, as this not requires a notary appointment each and every time a letter of grant gets handed out.
Strike Price / Exercise Price: The price determined at the time of grant at which an employee can purchase the shares of the grant.
(Letter of) Grant: Employee receives promise of future option.
Vesting: A period of time (e.g. 4y) over which the options become exercisable by the employee (this can occur on a monthly, quarterly or even yearly basis, so every time period a certain amount of options gets vested)
Cliff: A fixed period of time (e.g. 1y), the employee needs to stay in the company to exercise the first portion of granted options
Dilution: The reduction in the relative ownership (%) of a company for existing shareholders due to the creation of new shares, can occur as a result of a follow-on financing round.
Exit Event: This can be anything resulting in a substantial change of control over the company (e.g. sale, tradesale) or an IPO. At the exit event the employee with stock options gets the chance to participate in the exit events.
We truly believe in aligning our incentivize for the long term. Therefore, stock options reflect a substantial part of our compensation. Offering everybody a mandatory range, which can be adjusted to your particular ownership appetite.
We believe that this directly converts into our culture, fostering an entrepreneurial mindset within each and everyone. Because our success will be defined by the small decisions and the love for the detail on a day-to-day basis, as well as the strategic decisions guiding our path.
To be transparent it should be clear that we want to realize the upside together with you, why the virtual stock options also come at hand with a marketable cliff and vesting period, meaning you are basically unlocking more ownership the longer you stick around.