Stock Options Vesting Based on Milestones, Not Calendar Months

The Entrepreneur’s Manual has another powerful idea, one that I have never seen implemented. In all my years of working in and around high tech companies, I can’t think of a single one that has ever rewarded employees and teams with stock options based on achieving milestones; rather, all the options plans I have ever seen are based on a 3-4 year vesting schedule. As long as you don’t get fired, you get the stock, month after month.

Richard White says the best way to grant stock to employees is when they achieve pre-set milestones. One milestone might be shipping a quality product. 50,000 shares are issued. Another might be getting 2% market penetration. Another 50,000 shares. Then getting to positive cash flow for 3 consecutive months: 100,000 shares. Minimum profits of $100,000 per quarter: another 100,000 shares. Raising outside capital and making a competitive acquisition could have shares assigned to it. Every major and even minor milestone has some shares assigned to them.

Every milestone reached would result in shares being issued and divided among employees based on pre-determined ratios. If a company achieved all of its major milestones in the first year then the employees would celebrate having the entire stock option pool vested in one year–instead of four–but the investors should be happy too because the company reached all of its objectives much more quickly than they had expected.

I’ve got to learn more about this concept and whether it is used anymore. I love the idea of motivating teams to achieve results and not just pass time.

Who knows anything about this kind of stock option plan?

4 Comments

  1. Eliot W. Jacobsen

    Paul:
    I’m a big fan of rewarding goals met. In fact, in a previous company I led we tried to set up our option pool to be performanced based. But in the past, accellerating vesting schedules according to milestone achievements created an obligation for the company to record the acceleration as an expense in the period in which the accelleration occurred. This is why most companies do time-based vesting schedules. We decided to make it time-based and grant truly remarkable achievements additional options (while keeping the vesting schedule time-based).

    But now that companies must expense option grants and/or vesting in some cases, that disadvantage may be reduced, paving the way for more performance-based stock incentives. That would be good.

  2. I have seen milestone option plans showing up more frequently in technology oriented public companies.

    For example, this is taken from a recent SEC filing of Myogen:

    “On February 24, 2005, our Board of Directors reviewed our fiscal year 2004 results measured against the corporate goals established by our Compensation Committee and Board of Directors in the first quarter of 2004 (the “2004 Corporate Goals”). The 2004 Corporate Goals were based on the following five categories: (i) clinical development goals relating to enoximone, including goals relating to our EMOTE and ESSENTIAL trials; (ii) clinical development goals relating to ambrisentan, including goals relating to our pivotal phase III ARIES trials; (iii) clinical development goals relating to darusentan, including goals relating to our phase IIb clinical trial of darusentan; (iv) corporate goals relating to commercial partnership arrangements; (v) corporate and financial goals relating to resource planning and risk management measures; and
    (vi) drug discovery research and development goals.

    Our Board of Directors determined, upon recommendation of our Compensation Committee, that the company attained a specified percentage of our 2004 Corporate Goals. Based on this determination, the Compensation Committee and our Board of Directors approved specific cash bonus payments and the issuance of two tranches of options to purchase shares of our common stock. We issued the stock options in February 2005 and expect to pay the cash bonuses in March 2005.

    Both tranches of stock options were granted under and in accordance with the terms and conditions of our 2003 Equity Incentive Plan…

    Milestone Stock Options – Each of our employees, including each of our executive officers, was granted a “milestone” stock option. The size of the milestone stock option grants was calculated in accordance with a formula based on each employee’s salary level, bonus potential and length of service to the company. These options have a five (5) year term. One-hundred percent (100%) of the milestone options will vest if the average of our closing stock price equals or exceeds a pre-determined milestone level for any consecutive five (5) trading day period prior to termination.

    Notwithstanding the foregoing, if any of the milestone options have not vested prior to the date, if any, that we consummate a Corporate Transaction (as defined in our 2003 Equity Incentive Plan), such options shall instead vest over a four-year period (calculated from February 24, 2005).”

    The report from which the foregoing was taken is available at http://biz.yahoo.com/e/050302/myog8-k.html and the 2003 Incentive plan is available at http://www.sec.gov/Archives/edgar/data/1101052/000103570403000715/d95096a1exv10w1.txt

  3. I do perceive two conflicts while thinking of utilizing it in startup companies:
    1) Corporate milestones change and evolve rapidly together with the startup’s own self-definition (The long turning path of reaching an initial position in the industry) – so planning and measuring is quite difficult.
    2) The accountability for missing milestones presents a problem bigger in startup then in larger companies although it exists there as well. The problem can be demonstrated in the example of the sales department in a company did a really bad job while the engineering were terrific during the same period.

  4. Mark

    Milestone option sound good in theory, but create enormous conflict in the organization. First, even if you achieve your milestones, institutional invetors will require the options are vested on a 4 year schedule. Second, milestones will almost always come into conflict with the business plan as it changes in to the every changing business conditions and market. Stay with the time based option plansand provided bonus based incentives for intermediate goals. Third, it increases your chance of conflict and a law suit as interpretation on when a goal met can vary.

    For what its worth.

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