Non-monetary incentives are a repeated topic whenever either one of the following two events happen:

1. We are becoming a shareholder of a company.

2. The company is falling behind initial plan and looks for other ways to compensate its staff.

No matter the motivation, the outcome is always the same: a certain amount of the company’s stock is reserved for employees. Chris Dixon has commented on this with this brilliant post on his blog:

Option pool – normally 10-20%.  This comes out of the pre-money so founders should be aware that the number is very important in terms of their dilution.  Ideally the % should be based on a hiring plan and not just a deal point.   (Side note to entrepreneurs – whenever you want to debate something with a VC, frame it in operational terms since it’s hard for them to argue with that).

So, that’s the short version–in theory. We do reserve a certain amount of shares to be put into a pool initially. The board can then decide at any point to offer employees to receive a certain amount of options. These “options” entitles the holder (i.e. the employee) to make use of the option at any time and convert the option into shares. The employees are then free to chose when to exchange their options into actual shares.

There’s two reasons we do it this way:

1. Due to German tax law, anyone joining the company at a later time need to pay a price higher than the initial share price. Hence, “giving” shares for the initial price is out of the question. And buying shares of non-public companies can become quite expensive since German tax authorities can put a valuation at the company and then re-calculate the worth of the shares–if they want.

2. In order to keep the company’s board small and easy to manage, it is in the founders’ interest, that employees don’t immediately get voting rights. As pointed out before, employees will be reluctant to convert their options into shares until the company will go public or gets acquired. Only then they can use the proceeds from the sales to cover part of their tax liability.

So, due to 1., people are incentivized to exercise their options only shortly before the company gets acquired or merged. And because of 2., the company’s board is easy to manage and can stay lean.

I am a strong believer in non-monetary incentives and I believe this model is covering all possible bases on this issue. We hence recommend doing this with all of our startups.