When a company owner says an employee “thinks like an owner”, the phrase is conveying an extremely high sense of appreciation and gratitude. Employees like that are the Holy Grail for owners. Not that all thinking by owners is holy, far from it , it is just a way of the owner saying that they feel aligned with the employee. They feel the employee is making judgments and decisions that balance all the things an owner must balance (long-term vs short-term, certain stakeholders vs other stakeholders, investment vs harvesting, etc.). It is a relief to owners when they feel that someone is aligned with them. It is one of Warren Buffett’s favorite sayings that he invests in business managers who “think like owners” — to him, there is no higher appreciation.
If employees who think like owners are the holy grail, how does a business owner find and develop more of them? It seems obvious that enabling employees to become owners would do that. Stock options spring to mind because Silicon Valley legends have spread around the world with tales of stock option millionaires. The Google massage therapist and chef who both made millions. The artist who painted a mural at Facebook and made a hundred million.
Stock options are only one tool that is available to business owners. Like most tools, it is great in certain circumstances and counter productive in other situations. Restricted stock. Employee Stock Ownership Plan (ESOP, not the Employee Stock Option Plan variety). Phantom or Virtual Stock. Profit-sharing.
Stock Options and Employee Ownership
Each type of “incentive plan” (or maybe we should call them “alignment plans”) has different characteristics that make them better used in certain situations than in others. Below is a review of how stock options influence behavior if they are implemented in a company. Do stock options . . . . .
- Incent an exit? Absolutely. This is the greatest strength of stock options. In fact, stock options are best at encouraging moonshot investments — aiming everyone toward a moonshot exit event that is extremely difficult to line-up. There is virtually no way to cash in options unless there is an exit by the company (IPO being considered an ‘exit’ in this context even though a pet peeve of mine is that IPO’s should be financing events and not exits). I pity the founder who doesn’t want to sell his company when all the outside money investors and all the employees want to exit — the decision becomes fait accompli.
- Incent near-term profitability? Not at all. Options are not ownership so even if the company made a profit, the employee would not have a claim on that profit through her stock options (other than through a secondary effect of company reinvesting the profit for greater long-term value).
- Incent long-term employment? In my opinion, no. If the company reaches the exit, the employee also exits. If the company doesn’t gain traction, the employee also exits in search of stock options that could lead to an exit.
- Incent meritocracy? In my opinion, no. Because stock option programs are usually broadly shared and the measurement is the stock price, it is not tied to individual performance at all. So, there can be broad distortion whereby the people who created the value are not necessarily the ones who capture the value and vice versa. Compensation that is broadly measured is not necessarily a bad thing, the pros and cons just need to be understood.
If you want to aim everyone toward a moonshot exit in 3-5 years, you want to ignore near-term profitability, you want employees who can create value quickly in 3-5 years and then move one, and you want to foster legends of crazy upsides so there are armies of people ready to join start-ups, there is no better tool dreamed up by venture capitalists than stock options.
If you are a normal company, on the other hand, you may want to consider other methods. In future posts in this series, I will explore the similar pros and cons of other forms of employee ownership, some of which were mentioned above.
- Rich v. King? Spoils Go to Business Who Share and Delegate [November 6, 2012]
- Is it Better to Make Employees Fit Roles or Roles Fit Employees? [July 10, 2012]
- Science Says ‘Social Collaboratists’ are the Most Successful [April 23, 2012]