Study Finds Broad-Based Options in Venture-Backed Companies Both Common and Effective

Data on the extent and effectiveness of broad-based equity plans in closely held companies are scarce and based on samples too limited to be persuasive, but we recently came across one significant exception. In "Give Everyone a Prize? Employee Stock Options in Private Venture-Backed Firms" (2005, unpublished), John R.M. Hand of the Kenan-Flagler Business School looked at data from 2004 and 2005 provided by VentureOne, a provider of data on venture-backed firms. The sample consisted of 1,032 venture-backed companies responding to the survey for which adequate data were available. The study found the mean percentage of employees getting options was 89%, and 74% of the companies granted options to everyone. In other words, contrary to the conventional wisdom that broad-based equity awards have been disappearing in venture-backed companies, they are in fact almost universal.

Hand's study looks at whether granting options deeply into the organization is a good strategy for venture investors. He correlates the fraction of the firm's employees receiving shares and finds that granting options to more employees results in better performance than granting them more narrowly. The specific measures are too complex to describe here, but they essentially create a hypothetical optimal depth of options granted. Using that optimal depth, Hand concludes that firms that err of on the side of too many people getting options do better than those that err on the side of too few.

The argument here is that granting options too far down poses minimal risk because lower-level employees usually get smaller grants. In contrast, not granting far enough downthe ladder can create a substantial risk that potentially critical people will not be retained or motivated. So it is better to err on the side of caution.