To issue equity to employees and consultants, most startups set up a stock plan. A stock plan is a company program used to issue stock options or restricted stock to employees and consultants. Stock plans must be set forth in a legal document that is adopted by the board and approved by the stockholders.1 Startups typically set up stock plans as part of the corporate formation process, even if they don't have any immediate plans to hire people, because it is easier and cheaper to do all the paperwork at once rather than over time.
There are three primary benefits to using stock plans:
- When a startup sets up and uses a stock plan properly, the startup and its employees and consultants can benefit from advantageous tax regulations.
- Corporations must comply with securities regulations under federal and state laws whenever they issue any securities, such as stock or stock options. By default, a corporation will have to analyze securities regulations and potentially make filings each time it issues securities. With a stock plan though, corporations only need to make the analysis and any necessary filings once per relevant state, with respect to issuing stock or stock options to employees or consultants.
- By using standardized terms for all equity compensation, startups can reduce the amount of time and money they spend on legal due diligence in future financings and acquisitions.
The name of a stock plan usually includes the year in which the stock plan was adopted. For example, if your startup adopted a stock plan in 2016, it would typically be named something like 2016 Stock Plan. This is done to distinguish stock plans from each other, since a corporation may adopt additional stock plans in the future (though, this is infrequent).2
When a corporation adopts a stock plan, it must specify the maximum number of shares that can be issued under that plan. The corporation can change this number later by amending the stock plan with approval of the board and stockholders. The corporation must reserve that maximum number of shares for issuance under the plan, and must have enough shares available for issuance in order to do so. The reserved shares are often collectively referred to as an option pool or stock option pool.
The following are also terms commonly used to refer to stock plans:
- Stock option plans
- Employee stock option plans (ESOPs)
- Equity incentive plans
The term stock plan, as used in the context of startups, does not typically refer to:
- Employee stock ownership plans (ESOPs)
- Employee stock purchase plans (ESPPs)
These other types of plans have a very specific meaning, and are not commonly used by startups. Note that employee stock option plans and employee stock ownership plans share the same acronym, confusingly.