Accredited Investors – 5 Reasons Tech Startups Don’t Get Funded

Do you want to get your startup funded by accredited investors?

Do you want to meet accredited investors who can help you take your startup to the next level?

Many entrepreneurs spend a lot of time and money on investment websites searching for investors but don’t see the results they want.

They connect with angel investors but the conversation doesn’t go any where or they have a couple of phone calls and then conversation dies.

If this is you, Not all hopes are lost!

This doesn’t mean the “find investor websites” is a waste of time.

With some planning, you can turn your startup into a big time company. You can win more customers and investors to recognize your brand!

In this post, I’ll explain 5 reasons tech startups don’t bet funded by accredited investors.

Not only that, but we know you probably want to know what you can do to reduce the amount of time and energy you spend on developing investment materials too.

It can be a real energy suck. We’ll give you some tips and tricks to cut the hours you currently spend on find investor websites.

1. Your Stage Is ‘Too Early’ And You Have No Traction To Prove Your Business Sustainability To Accredited Investors

Target Customers To Show Accredited Investors
Your Ideas Alone Won’t Get You Funded. Generate Customer Interest And Traction Before You Approach Any Accredited Investor. Companies Who Show Early Stage Traction Are 80% More Likely To Be Funded.

Most of the time we see entrepreneurs who are very passionate about their startup seek investment or working capital for their idea way too early during the idea and product development phase of the company.

Though it’s not bad to begin searching for investors early, ideas alone won’t get you funded.

The myth we all know is that, every investor is rich and loves a great profitable business idea.

Though a business maybe profitable, an investor may not be attracted to invest because the return on investment may not be the greatest for the investor.

New investors are happy to make a ROI between 3 to 10 times the initial amount he or she invested. Experienced investors expect a ROI between 5 to 50 times the initial amount he or she invested in your startup.

How Much To Ask When Raising Funds From Accredited Investors

  • We usually recommend founders to seek between $10K to $1M from angel investors and from $250K to $100M+ from venture capitalists.
  • Angel investor funds can be used to complete the product development
  • Venture capital funds can be used to expand the startup

The reality here is new entrepreneurs forget, great ideas means nothing without customers and founder credibility.

For example: It will much easier for Elon Musk to raise $100 million dollars from investors compared to a small startup owner nobody knows about. right?

Investors do not invest in only ideas, they also invest in the capable team you bring on board.

Since the explosion of mobile apps and websites, tech companies are typically being considered as “High Risk Businesses” and this is simply because they are easy to fail.

To make it easier for your company to raise funds, bootstrapping your startup could be the cheapest way to earn a free ticket to meet accredited investors.

What Is Bootstrapping A Startup Company?

Bootstrapping a company means running a startup without outside working capital.

There are few things that happen when you bootstrap your company:

  1. It demonstrates your commitment and belief in your company to investors: The amount of money you invest in your startup can tell investors how much you believe in your idea.
  2. You learn to spend where it matters and focus on what is most important to the business.
  3. The amount of money, time and effort you put in your startup during the product development phase can be considered in your deal negotiation with investors.

2. You Have Presented An Overwhelming Business Plan And Pitch Deck

Accredited Investor Looking At Overwhelming business plan
Don’t Present Investors With A Clumsy And Overwhelming Business Plan. Keep It Short And Impactful. State Only The Facts And Benefits, Show How Much People Need Or Care For Your Product / Service. The 3 – 5 Years Projected Financials You Present Must Be Realistic.

This point should have been number 1 and as serious as it sounds, some entrepreneurs prepare investor business plans about 300 pages long.

It is completely not necessary to have such a long business plan. 99% of accredited investors won’t have the time to read everything in your business plan.

Tech Investor Network typically recommends, 10 – 50 pages long and usually, that should be enough to cover all the necessary information about your startup.

Download The Free Recommended Guide On “How To Write A Winning Business Plan”

3. Having Zero To Little Knowledge About Your Competition 

No Knoledge About Business Copetition
You Should NOT Use Vague Principles and Believes On Any business. In Modern Business, Data Is King. Knowing More About Your Competitors Can Help You Forecast A Better Future

Many tech startups do not get funded because they do not know who their competitors are and even if they do, they know very little about them.

The mistake most tech founders often make is getting overly attached to an idea.

They get too attached to their idea or project without doing proper due diligence on the existence of idea.

Then they quickly rush to build a prototype, only to find out the product or service already exists.

How To Find Out If Your Idea Is Unique

The best way to find out if your idea is feasible and unique without doing a patent search is to study your direct and indirect competitors.

Study and analyze how your competitors have evolved with their product or service they developed over the years and this is the true mastermind…

You can also simply do a patent search provided to you by your local government as well to see some of the technical details if you need more information and assurance of the ideas existence.

To convince an investor that you know about your competitors, you should be able to know exactly what they do.

In your discussions with accredited investors, mention where your competitors operate, their previous investment amounts, latest accomplishments or failures etc.

It is always best to know your competitors thoroughly.

Competitor intelligence can help you know if you’re winning or losing a market share.

4. You Have No Customer Acquisition Plan

Customer acquition plan - Accredited Investors
Customers Are The Lifeline For Every Brand. Investors Love Companies With Many Customers, Demonstrating How Effectively You Can Acquire New Customers Tells Investors The Worth Of Your Startup In A Quick Brief.

Developing a customer acquisition plan involves the integration of several marketing channels which can include:

  • Mass Media
  • Social Media
  • Search Engine Marketing
  • Paid Advertising
  • Strategic Partnerships Etc.

A well designed customer acquisition strategy must consider the best form of strategies available considering passive lead generation strategies.

Have you ever heard the saying that, “without marketing a business can’t survive?”.

Having a great idea is one thing, and having no solid customer acquisition strategy would shut down your business faster than you started it.

Many great businesses have closed today because other businesses came out with a better customer acquisition and satisfaction strategy.

The famous Toys R Us chain of retail stores which served North America for many years had to shut down due to the growth factors of Amazon and the like.

Here Are 12 Effective Ways You Can Acquire New Customers:

How to acquire customers to show accredited investors

  • Search Engine Optimization
  • Search Engine Marketing (PPC) Reputation Management
  • Referral Programs
  • Email Marketing
  • Direct Email
  • Merchandising
  • Events
  • Community Service
  • Print
  • Mass Media: Tv, Radio, Newspapers & Sponsorships
  • Public Relations
  • Strategic Partnerships and Affiliates

5. There’s No Team Behind The Idea 

No Team To meet Accredited Investors.png

A startup with only a single member as founder and manager could prove difficulty when accredited investor funds are needed.

Investors understand that startup companies require a lot of mental and emotional strength to keep the company running.

If your product is 100% completed and does not require a team to run the business, you can seek investors else we recommend you consider partnerships with credible individuals.

A startup with a team that can demonstrate experience, practicality and some traction usually has a 90% chance of getting funded by accredited investors.

Conclusion

Accredited investors usually do not invest in just an idea. Having a prototype or patent helps them get a better picture of your overall idea.

Startups that use the Tech Investor Network Investor Funding Service are usually investment ready and require working capital between $20K and $100M+.

Startup Funding – Get Your Tech Company Funded Today

How You Can Add Emails To The ‘Safe Sender List’

The safe sender list is simply a manual way of telling your email provider that incoming email a domain, which in this it’s case techinvestornetwork.com should not go to spam.

Email providers such as yahoo, gmail and others are putting in efforts to provide quality electronic mail services and to avoid missing important emails you are required to add new contacts to the safe sender list.

We have provided steps on some of the popular email providers available. The steps are pretty much standard for every email provider.

The good thing about this is that you only need to do it once. Let’s get started…

Adding Emails To The ‘Safe Sender List’

Yahoo

In Yahoo Mail, your Contacts list is your whitelist. To add the From Address to your Yahoo Contacts:

  1. Open your Yahoo mailbox.
  2. Click the address book  icon under the Yahoo! Mail logo. When you roll your mouse over it, it will say Contacts.
  3. Click “New Contact”.
  4. Fill in the fields of your Contact.  (add ask@techinvestornetwork.com)
  5. Click Save.

For additional help with whitelisting email addresses in Yahoo, please see Yahoo’s support.

Outlook.com

  1. Open your Outlook mailbox.
  2. Select Options from the top right (next to the question mark).
  3. Select More options > Safe and blocked senders (under Preventing junk email) > Safe senders.
  4. In the space provided, enter the address. (add ask@techinvestornetwork.com)
  5. Select Add to list.
  6. Ensure the safe mailing lists box has the address you entered, and select OK.

For additional help with whitelisting email addresses in Outlook, please see Microsoft’s support.

MSN

  1. Select Settings: Email | Junk e-mail (bottom left, just above Calendar).
  2. From the E-mail settings screen, select Junk E-mail Guard.
  3. Select Safe List.
    (add ask@techinvestornetwork.com)
  4. Select Add.

For additional help with whitelisting email addresses in MSN, please see Microsoft’s support.

Gmail

To ensure that you receive emails in your inbox, you can add the email address to your contact list. If one of our mails has been moved to the spam folder, you can mark it “Not Spam” to whitelist it.

  1. Select contacts from the options on the left side of the Gmail Inbox.
  2. Select “Create Contact” on the top menu.
  3. Enter the ask@techinvestornetwork.com in the primary email box.
  4. Select Save.

For additional help with whitelisting email addresses in Gmail, please see Gmail’s support.

MacMail

  1. Open the email.
  2. Ctrl-click the sender’s email address and select “Open in Address Book.”
  3. Verify the sender’s contact details. (ask@techinvestornetwork.com)
  4. Click Save.

For additional help with whitelisting email addresses in MacMail, please see Apple’s support.

AT&T Web Email

  1. Open your mailbox.
  2. Select Options on the top right hand side > Mail Options > Filters > Add Filter.
  3. Select Filters.
  4. Click “Add Filter”.
  5. In the top row, labeled From Header, select “contains” from the pull-down menu. Enter ask@techinvestornetwork.com in the text box next to the pull-down menu.
  6. Move down to the bottom where there is the option “Move the message to”. Select Inbox from the drop-down menu.
  7. Select the Add Filter button once again.

For additional help with whitelisting email addresses in AT&T, please see AT&T’s support.

Verizon

  1. Open your Inbox.
  2. Click Options.
  3. Click Block Senders.
  4. Locate the Safe List.
  5. Enter your contact’s domain. (techinvestornetwork.com)
  6. Click OK.

For additional help with whitelisting email addresses in Verizon, please see Verizon’s support.

Private Equity

What Is Private Equity?

Private equity are funds investors use to purchase shares in private companies. Also, It can be described as the shares outside the stock exchange.

Private equity can be provided by angel investors, venture capitalists and other investment institutions.

Who is A Private Equity Analyst?

A private equity analyst is a person who conducts research and forecast the return-on-investment (ROI) of a company by ratio analysis.

What Are Private Equity Firms?

Private equity firms are investment management institutions set up to raise funds from different sources and invest into buying and selling of businesses for profit.

What is a private equity firm?
Understanding How Private Equity Firms Works

What Do Private Equity Companies Do?

Private equity companies are usually formed by investors who want to directly invest in companies rather than buying stocks. The goal of the private equity firm is to buy highly profitable companies with growth potential

How Do Private Equity Firms Work?

Companies that are acquired by private equity firms are considered as portfolios to the firm. The private equity firm controls the acquired company by representing its members as board of directors in the acquired company.

Private Equity Funds For High-Tech Companies

How Do Private Equity Firms Raise Funds?

Private equity firms raise funds through several mediums, The list below shows the most common methods private equity firms use :

  1. Public Pension Funds
  2. Corporate Pension Funds
  3. Insurance Companies
  4. High Net worth Individuals
  5. Family Offices
  6. Endowments
  7. Foundations
  8. Funds – of – funds
  9. Sovereign Wealthy Funds. etc.

What Is The Difference Between Private Equity and Venture Capital?

A private equity firm usually buys 100% of the companies they invest in, as a result they control the entire company after buyout. Private equity firms also use cash and debt in their investment while venture capitalists deals with equity only.

Related: read the History of equity and venture capital on wikipedia

What Do Private Equity Firms Invest In?

Private equity firms invest in almost all types of profitable businesses. This includes startups, mid-stage companies and late stage companies. Industries private equity firms invest in includes Agriculture, High-Tech, Clean Energy, Hospitality, Finance, etc

How Private Equity Firms Can Help You

Here are 5 common scenarios private equity firms can help your company:

  1. Capital for Expansion: As successful business owners grow, funds becomes a greater need but with the help of a reputable firm you can expand and take your business to the next level.
  2. Buyout Existing Investors: In some cases investors who have their money tied up for 5 years or more in a privately held company can become “Tired investors”. In this scenario, the underlying company must show a positive financial projection before the buyout can be doable.
  3. Payout The Founder or Owner: It is also possible for only the founder to be bought out while keeping the old investors. This often happens when the founder wants to move on, due to illness, divorce etc. Typically, investors are very interested in this kind of option especially when there is a controlling stake available.
  4. Buyout The Company: The great thing about private equity firms is that, they have large amounts of cash on hand. They create no uncertainty for founders because they can buy 100% of the company, cash outing out previous investors, shareholders and founders. In some cases thy may retain the founder to continue to manage the business but they can also use the funds install a new senior management and board of directors.
  5. Restructure A Struggling Business: Private Equity Firms can provide adequate capital to help a profitable business restructure its business if it shows a near turn around.

Related: Employee Stock Option Plan (ESOP)

Best Tips On How To Write A Business Plan

,how-to-write-a-business-plan-for investors

Get A Quote For A Custom Tailored Business Plan Investors Can’t Reject

The Outcome: At the end of this article you will know how to write a business plan Step By step that investors will be impressed about. You will also help you set up your business plan as tool you can use for your overall business success.

Do you know anyone who has written a business plan but rarely opens it to find business strategies? At Tech Investor Network we strongly recommend and encourage our clients to learn about the importance of well-documented business plan which serves as tool for business growth and development.

What is a business plan?

A business plan is a tool that describes your company in detail and how it operates. A business plan can also be considered as the overall blueprint your business structure..

What a business plan is used for?

A business plan is a communication tool used to attract investment funding or capital from angel investors, venture capitalists or financial institutions.  A business plan can be used as a strategic tool to create valuable business partnerships and importantly to show the profitability of a startup.

The scope of business plans varies but below is the standard outline for most business plans and as you scroll down, you will see a comprehensive business plan outline we recommend you use as your guide when creating a business plan for investors especially.

  1. Contact Information (Your company name, phone number, address, email etc)
  2. About Your Company (Profile) – What does your company do ?
  3. Market – Who are your customers and where can they be found?
  4. What is your product or service? Any benefits?
  5. Financial Analysis – (Future prediction or revenue / profit
  6. Implementation strategy – (Short term and long term strategies)
  7. Management team – (Any partners? skills?)

Business plans are like the grand architect blueprint for your business, however most amateur entrepreneurs prepare a business plan with bad or rushed content, present it to investors and expect to be funded. Even worse, some entrepreneurs start a business without a business plan. Can you imagine building a home without having a plan?

The reality check here is, “Would you hand over your money to the architect who designs a beautiful home for you with no solid foundations?” The answer will be an out right NO!, because, for most people (Investors) will not like to run at loss for mistakes which can have avoided.

All hope is not lost, and for this reason we encourage you to learn how to write good business plan in a way investors will be impressed about when they begin to reading it.

Our recommended outline below will quickly help you answer all the question investors will be asking. Now, after going through the business outline below you will read on the 4 main pillars every business plan have and every entrepreneur must know this, They are the: WHAT, WHO, WHY and HOW

The Best Business Plan Outline For Investors

 

Investment applications require the submission of a business plan. This outline is provided as a guide only, and we understand that some early stage enterprises may not be able to complete all sections until they are operating or in a position to obtain certain kinds of information.

However, the more complete the business plan is, the easier it will be for investors to understand and evaluate your business proposition.

Although the Tech Investor Network does not prescribe a set format for a business plan, this one lists what most investors are looking for.

1. EXECUTIVE SUMMARY

An executive summary is an overview of the entire company

2. SUMMARY OF THE OPPORTUNITY AND COMPANY

The Opportunity

What is it? How does it work? What is the business model? How will it grow? Which strategic industry is it in?

Company History

How did the opportunity occur to you. How did you get started? Who is on board? What have you done so far

3. OVERVIEW OF PROPOSED PRODUCT, SERVICE OR TECHNOLOGY

Describe the product, service or technology in detail.

What it does. How it works. How it is used. What it looks like.

Describe The Innovation

What is new about your product, service or technology? How is it different from what is available now?

Value proposition and customer needs

Why does your customer need it? What is in it for them?

Is any part of your proposition patented, copyrighted, trademarked, or registered? What is the status?

4. MARKET OPPORTUNITY

Market Analysis

Describe the overall market, the primary industries associated with it, and how your opportunity fits in.

Target Market

Describe the portion of that market you will target. Describe the customers and users.Why they are the ones that represent your value proposition

Competitive Landscape

How is your target market meeting its needs now? Who or what is thecompetition? How is your product, service, technology or business model different from theirs? Do you see opportunities they don’t?

5. COMPANY MANAGEMENT

Description of the key personnel in terms of their talent, skills and experience.

Human Resources Plan

Description of positions that need to be created, how they will be filled, and when.

Resumes of founders and existing or proposed shareholders.

6. DEVELOPMENT PLAN

  1. Description of product, service or technology development milestones and proposed timeline.
  1. Description of sales and marketing strategy, including revenue model.

7. FINANCIAL PLAN

Projected cash flow statement

Investment needs, short term and long term financing requirements

8. FOR FUNDING

Please submit your request electronically in Word or PDF Format to ask@techinvestornetwork.com or click this link to upload.

If your proposition doesn’t clearly fit with one of our strategic industries, or if you have questions regarding information disclosure or omission based on the above outline, please contact us so we can assess it and give you feedback about its eligibility.

The Four Pillars Every Business Plan Must Have To Reach The 85% Potential Of Getting Funded By Angel Investors

For every good business plan there are four categories of questions that must be answered to reach that 85% potential of getting investor funded.  To reach there you have to answer the following:

Questions Investors Ask

  1. What?
  2. Why?
  3. Who ?
  4. How?

The “What”?

1.  What is the problem? or What is the one thing you have a solution for? (Describe your problem statement):

What particular problem does your idea / solution / service or product product solve? This is the most vital part of your business structure because it plays a key role in:

  • The number of existing cases or number of people with the problem described

The rule of thumb here is that, tech investor are looking for businesses that are scalable to invest in. Technology startup or companies that have less geographical restrictions are 97% more likely to find investors who are looking to invest for huge return on investments (ROI) since they have the idea that they can become a global tech company.

  • Why does the problem exist?

Understanding why a problem exists can lead you to your greatest competitive advantage.  understanding the cause of a problem can help you find better a competitive advantage. For example, If you know a problem exist because your competitors prices are high, by lowering your price a few cents could solve the problem temporarily but knowing how your competitor fully operates can help you understand and master the true art of industry leadership. For instance, by knowing what it cost your competitor to create a particular commodity or product, you make strict decision on pricing structures that can help you lead the market. This is one of the reason we encourage a deep market research.

2.  What do you need?

  • Financial Plan or Budget Plan
  • Human Resource Plan

Financial Plan or Budget Plan

As humans, we have a natural habit of having high value for things we own. determining the financial or budget plan for your company is as a crucial as the main reason why you have decided to start a business in the first place. Even though you may not have all the figures correct, it is recommended you show your burn rate for all the departments for the next 3 years including cash in and out, expected returns / profit.

Here are the 4 points you should cover in your financial plan

  • Expenses (Burn)
  • Return On Investment  (ROI) / Profit
  • Budget
  • External Fundraising

Human Resource Plan

The Team You Need For Your Company

For every business your team is your first asset. The unspoken truth is that, a team of highly talented individuals or renowned candidates as startup or company partners can help the right guys help you get funded by venture capitalists.

In this section thoroughly explain the capabilities, strengths and efforts of the team. You can do this by updating your resume and and dedicating a section of the page for each team member.

In describing the the team some of the key points to look out for are:

  • Resources required for the project
  • Detailed Project Plan
  • Financial Requirement
  • Effort Estimation

The “WHY ?”

Why Customers Should Use Your Service / Solution Or Product

You need to have a justifiable analysis to of the market to prove your product is or will be needed. You can use the minimum market data analysis such as industry cap, market cap, competition revenue etc.  By doing this you should drastically differentiate yourself from your competitor. You can usually do this easily by building a different brand identity and social voice. However you should point out, what your unique selling points? How you can differentiate from competitors and what value you can create for customers.

In this WHY section, you should cover

  • How you create value for customers and for your company
  • What makes you different form your competitors and
  • What is the cost or time advantage of using your product or service. For example by using www.techinvestornetwork.com, you can save yourself tons of time and investor rejections by meeting with investors in our network who are most likely to invest in your tech company.

The “How”

How To Reach Potential Customers (Marketing Strategy)

Your marketing strategy should be refined and well targeted enough to reach the right customers for your business. It is a known that fact that without marketing the best product will not sell. Marketing is compulsory for every business because it is what generate the sales to keep your business running. To design a marketing strategy that investors want, you must keep updating your marketing research based on the market demand and customer behaviour. Points you should cover in your marketing area includes:

  • Digital Marketing
  • Traditional Marketing
  • Media And Publishing
  • How You Will Target Your Ideal Customers
  • How Your Sales Team Will Close A Sales

Building A Brand Strategy

Building brands are not expensive. Information you share on the internet and media can quickly help you build a brand.  The use of paid advertising is a great way new brands can establish credibility and build a loyal fan base. In marketing area of your business plan, explain how you can leverage public resources and free resources to build a brand

Resource You Can Use To Build A Brand

  • Media And Publishing
  • Digital Marketing
  • Influence Marketing
  • Strategic Business Partnerships

Operations Plan

The Operation plan for most business carries a big share in some enterprises. Many things go under operations which is not technology and human resource. In this section you should clearly explain the major key operations of your company.

by covering the points below you will make it easier for investors to understand your business and get you funded.

  • Infrastructure Plan
  • Disaster And Recovery Plan
  • Method Of Department Communication
  • Facilities

The WHO?

Benefits & Rewards For Stakeholders

The one thing we always encourage at Tech Investor Network is communication. Because you are literally dead without it. Sometimes the right communication with stakeholder management can help your company flourish to where there is no limit. Every individual associated with your company is responsible and directly or indirectly affected by the benefits of the business. Here are a few topics that must be addressed in this area of the business plan

  • Mode Of Communication
  • Frequency Of Communication
  • Roles And Responsibilities

Who Are the Target Customers

Targeting customers are the right place at the right time has been made easier with tools like google ads, LinkedIn ads and Facebook ads. Planning your media targeting and lead generation requires the help of an expert in marketing but the minimum data needed to understand your customer will include

  • Customer Demographics
  • Target Customer Analysis
  • Insights
  • Behaviour
  • Income Group
  • Repetitive Order Plan

The Executive Summary

Your executive summary is all the detail in your business plan summarized for investors and 3rd parties to quickly read and understand what your entire business is about without having to red the business plan itself..

HERE ARE THE 4 THINGS PEOPLE WILL ALWAYS PAY FOR

1. Convenience

2. Leading Edge Product or Service

3. Apps or Service That Makes Money; such as: bitcoin mining

4. Passion; Tools that allow individual to express their passion such as creative writing, advanced Virtual Reality Games, Painting, Photography tools and digital editing software etc.

DIFFERENCE BETWEEN ANGEL INVESTORS AND VENTURE CAPITALISTS

what is the difference between angel investors and venture capitalists

As general rule, angel investors are individuals who will put in seed funds in potential startup and usually invest less than $1 million dollars. However, venture capitalist firms are designed to offer you funds when your business is ready to expand.

DO I HAVE TO PAY BACK IF MY STARTUP FAILS?

You don’t have to back the funds investors put in your business if your startup fails. The goal of the investor is usually to sell his/her share 5 – 15 years down the line for a significant profit and this is the main reason investors can be picky on who they invest in.  For this reason, we encourage entrepreneurs to present their business plan in custom tailored fashion to portray your business strengths, weaknesses in a strategic way which will quickly communicate and direct the investor to the opportunities your startup has to offer.

Employee Stock Option Plan (ESOP)

Employee Stock Option Plan Guidelines [ESOP]

Tech Investor Network, helps new start-up companies raise venture capital investments and angel investment in Canada and United States Of America.

To find out more about Tech Investor Network, please visit our website at www.TechInvestorNetwork.com or call us at

1-365-338-3391 (North America only) or email ask@techinvstornetwork.com

By Ryan Rocafella

Don’t have time to read now? Send it to my email now 

 

  1. INTRODUCTION
  2. WHAT IS AN ESOP?
  3. ESOP OBJECTIVES
  4. ESOP COSTS VERSUS BENEFITS
  5. STOCK OPTIONS FOR START-UPS AND SMALL COMPANIES ESOP EXAMPLE
  6. CONCLUSION
  7. GLOSSARY OF TERMS
  8. RESOURCES

Introduction

Employee stock option plans, also known as ESOPs, have been popularized by the success realized by technology firms such as Microsoft and Cisco Systems in that the implementation of stock option plans has resulted in great personal wealth for the early employees of these companies. ESOPs however represent much more than a scheme whereby high tech employees can expect to get rich quickly off their stock options. These plans represent a means for a given enterprise’s various stakeholder groups to mutually benefit and generate lasting wealth, not only for the individuals associated with the company, but also for the region in which it is located.

 

From the perspective of a given firm, the benefits of an ESOP include:

 

 

Use as a tool to attract and retain key or skilled employees; Creation of an ownership mentality among employees; The recognition and valuation of the contribution of employees; Productivity and competitiveness boosts; Use as a potential exit strategy for owners; and Lower the expectation for a company pension plan. From the perspective of an employee, the benefits of an ESOP include:

 

 

Ability to directly share in the success of the enterprise; Representation of worth to the employer; 

The potential for significant tax savings upon share disposal; and Instillation of pride due to ownership mentality and job satisfaction.

 

 

 

From a broader social perspective ESOPs also provide value in that they Represent an opportunity for relative advantage within an increasingly competitive global economy; Compatible with the trend toward broad-based stock ownership; Have the potential to create long-term, capital-based wealth among employees; Represent a tangible solution in narrowing the ever increasing real wage gap; and Provide an alternative to government-sponsored/ provided retirement plans. The benefits and past successes of such plans are apparent but the implementation of an ESOP should not be interpreted as an instant guarantee of success. Significant care must be taken to ensure that an established plan meets both corporate objectives and the needs of the employees.

 

What is an ESOP?

 

In formal terms, an ESOP is an employee equity ownership plan that can include stock, stock

options or what is often referred to as phantom stock.

Stock equity is a legal transfer of ownership of a share of stock issued by a company.

This ownership may or may not come with additional rights such as voting or dividend receipt. The ownership of stock in a firm places the employee in a risk-reward situation such that the firm’s success should result in the accrual of value to his/her equity position.

 

 

 

Stock options represent terms under which the company proposes to sell equity to its employees at some point in the future with the price fixed in the present day. The risk-reward profile of stock option entitlement is lower than that of equity ownership given that if the value of the company’s shares decline over time the options are simply not exercised with no actual net loss realized by the employee. Stock option plans are widely applied particularly in the technology sphere given they represent a fairly low-cost source of employee compensation for the firm and provide maximum benefit to the employee.

 

 

 

Phantom stock (or participation plans) units mirror real stock equity other than the exclusion of actual voting rights. No legal transfer of ownership generally takes place until a liquidity event occurs at which point the phantom stock is fully convertible to real stock equity. Phantom stock is also known by the term SARs (Stock Appreciation Rights). Such plans are often restricted to key management or implemented in firms where the owners are unwilling to share control of the enterprise.

 

 

 

The key elements of a successful ESOP include

a) Compatibility with the long-term strategic goals of the enterprise;

b) Compatibility with the culture and structure of the enterprise; and

c) Proper degree of flexibility with regard to the implementation of the plan.

 

 

One of the keys to successful ESOP implementation is flexibility so that a plan can apply to a small number of employees or be spread across the entire business. It might consist exclusively of shares or alternately a combination of the three above-mentioned forms of equity. A firm’s management has the flexibility to design and implement an ESOP that most closely matches up with both the company’s long-term strategic objectives as well as its corporate culture. The decision as to which instruments should be used in the establishment of an ESOP is usually based on corporate strategy, corporate culture and management style. This analysis is an oversimplification however as the motive for the establishment of an ESOP must also be considered in any such analysis. Firms that wish to attract and retain key employees and/or restrict cash employment expenses are better candidates for stock option plans whereas a company wishing to provide its employees with an alternative to a formal pension plan or those which intend to use an ESOP as a liquidity event for current ownership should consider a stock equity plan.

 

ESOP Objectives

 

From the perspective of an individual company, the high level objectives of ESOP implementation include addressing such issues as:

 

Employee recruitment and retention; Employee productivity; Company competitiveness; Firm profitability; Low cost business financing; and Succession planning.

 

Numerous studies and surveys indicate that ESOPs do indeed help to attract and retain a motivated work force with the added benefit of increased productivity and profitability. Virtually every commissioned study supports these conclusions. For further discussion of this matter, visit the National Center of Employee Ownership (NCEO) website at www.nceo.org. 

 

 

 

The consensus is that ESOPs tend to foster a corporate culture where a motivated work force sees the benefits in sharing ideas, trimming costs and working more productively. A key benefit to the employer of ESOP implementation is undoubtedly the ability to attract and retain motivated workers. A key asset for any firm, large or small, is the caliber of its employees with both the value and knowledge they provide to the enterprise. A broad-based ESOP, specifically a stock option plan, is often a prerequisite to guaranteeing access to skilled & motivated employees and a key to retaining these individuals for extended periods. The productivity and competitiveness benefits are evident from the studies conducted. Some of the other benefits require further explanation however. From a business financing perspective, ESOP-adopting firms (particularly start-up and/or high tech firms) are able to develop broad compensation schemes that enable the companies to save valuable cash and effectively pay their employees wages either at or below prevailing market rates in exchange for equity in the company.

 

Most stock option plans also explicitly require a reasonable purchase price on the part of the employee thus generating another source of capital for a young firm.

 

From a succession planning perspective, an ESOP can provide great flexibility for privately held companies. A primary issue facing many business owners is how to retire from and sell a long-held company. In many cases, the best solution, for a variety of reasons, is to sell out to the firm’s employees. In this instance an ESOP ensures that an owner can remove his/her money from the company over time and ensure its continued operations in a fairly seamless manner.

 

 

There are many benefits to such a transaction including a close hold on financial information, the assurance of continued stewardship of the company, lower transaction fees and numerous tax advantages that may accrue under such mechanisms.

 

ESOP Costs versus Benefits

 

The benefits of an ESOP tend to accrue to both employees and employers. As noted previously employers tend to benefit via:

Higher productivity;

Increased profitability;

Employee motivation; and

Employee retention, among other factors.

Employees derive a direct benefit from such plans by virtue of: 

Sharing in employer’s success;

Increased job satisfaction;

Favourable tax treatment (deferral of income) by CRA;

Financial upside (often with limited risk); and

Potential to progress from employee to owner over time.

 

 

 

The benefits do not come without some costs however and from the perspective of the employer these relate primarily to ownership dilution for the existing shareholders, the cost & effort of plan establishment and the cost & effort of plan administration. From the perspective of the employee, the tradeoff is often lower direct cash compensation and the increased financial risk in that their wealth is tied up in the enterprise in exchange for the upside of ownership. And finally, many plans have few voting rights so in some respects the employees can be highly invested relative to their overall net worth but have minimal direct control over the investment. Notwithstanding these issues, the benefits of ESOPs are generally perceived to outweigh the costs in most instances. For example, even in the smallest firms, stock option plans can be established with very low cost and minimal recurring effort. The potential value of such a plan for a small firm cannot be overstated given the probable positive impact on employee recruitment, retention and productivity.

 

Stock Options for Start-ups and Small Companies

 

A stock option plan gives an employee the right to buy a certain number of shares in the company at a fixed price for a certain number of years. The price at which the option is provided is called the strike price and is often the market price (or fair market value – FMV) at the time the options are granted. Option holders hope that the share price will rise and that they will be able to “lock in” such gains by exercising (purchasing) the stock at the lower strike price and either holding the shares or selling the stock at the current market price, realizing an effective gain in either instance.

 

Most shares granted under an ESOP are only saleable however either upon an employee’s departure from the firm or a liquidity event such as the sale of the company to a third party or an initial public offering (IPO). Under a typical plan the options are generally subject to vesting so an employee might get, for example, the right to purchase 25% of the shares available under the grant after two years (the “cliff”), 50% after three, 75% after four, and 100% after five. A common exercise term would be in the seven- to ten-year range. It is worth noting however that a vesting schedule can be as simple as the one shown above or it can in fact be quite complex with any number of input variables and contingencies in place. It is the responsibility of the firm’s management to ensure that the choice of a schedule is consistent with both the firm’s business plan and its motives for the creation of an ESOP.

 

Significant care must also be taken to ensure that the plan’s vesting schedule is not too complicated so as to alienate and/or confuse the employees it is intended to benefit. Stock options grants are typically allocated either as a proportion of an employee’s total compensation package (e.g., annual option grant bonus of 15% of base salary) or as a proportion of the total shareholders’ equity of the firm (e.g., employee can earn up to 5% total ownership via ESOP over 10 years). The second mechanism, where options are allocated on the basis of total firm equity is perhaps the better option from the perspective of the alignment of long-term interests between employer and employee but it is the first scheme, whereby the allocation is a proportion of salary that may appear more attractive to employees. It is management’s prerogative to pursue the course that best benefits both the firm and its employees.

 

 

Traditionally, stock option plans have been used as a way for companies to reward top management and key employees and link their interests with those of the company and other shareholders. More and more companies, however, now consider all of their employees as key. As a result, there has been an increase in the popularity of broad-based stock option plans, particularly since the late 1980s. Such plans are now the norm in high-technology companies and are becoming popular in many companies in other industries as part of an overall equity compensation strategy. As of 2001, the NCEO estimates that, within the United States, up to 10 million employees receive stock options as part of their compensation packages. Stock option plans are now viewed as a flexible way for companies to share ownership with employees, reward them for performance, and attract/retain a motivated staff. For growth-oriented smaller companies, options are a great way to preserve cash while giving employees a piece of future growth. The dilutive effect of an option grant is typically very small and should be offset by the potential productivity and employee retention benefits.

 

 

The ultimate impact of any employee ownership plan, including a stock option plan, depends a great deal on the company and its goals for the plan, its commitment to creating an ownership culture, the amount of training and education it puts into explaining the plan, and the goals of individual employees (whether they want cash sooner rather than later). In companies that demonstrate a true commitment to creating an ownership culture, stock options can be a significant motivator. One of the most important considerations for the plan design is its purpose: is the plan intended to give all employees stock in the company, or just provide a benefit for some key employees? Does the company wish to promote long-term ownership or is it a one-time benefit? Is the plan intended as a way to create employee ownership or simply a way to create an additional employee benefit? The answers to these questions will be crucial in defining specific plan characteristics such as eligibility, allocation, vesting, valuation, holding periods, and stock price.

 

ESOP Example

 

A typical outline for a stock option plan agreement should delineate the following sections, at a minimum (Note – the items with bullets are examples of information which may be found within the appropriate subsection):

 

1. Interpretation

• List of legal terms and definitions

• Indication of legal jurisdiction

2. Purpose

• Description of purpose behind plan

• Brief description of underlying shares in question

• List of counterparties to agreement

3. Administration

• Description of plan administrator (typically Company’s Board of Directors)

• Description of administrator’s authority

4. Securities Subject to Plan

• Detailed description of securities underlying the plan as well as the number of shares

outstanding under the plan

5. Participation

• Detailed description of persons eligible to participate in the plan

• Brief description of option granting process

6. Terms and Conditions of Plan

• Detailed list of terms and conditions governing the granting process and the features of

the options granted including, but not limited to:

a. Price

b. Payment

c. Term

d. Vesting Period

e. Exercise

f. Termination Clause

g. Regulatory Matters

h. Transferability Issues

7. Conditions of Option Grant

• Description of option plan status under a variety of liquidity events

• Reference to participation in any Shareholders’ Agreement(s)

• Description of option plan status under events of company default or reorganization

8. Adjustments to Underlying Securities

• Description of anti-dilution provisions for plan subscribers

9. Amendment and Termination of Option Plan

• Description of conditions and events required to alter the structure or administration of

the plan

10. Effective Date and Duration of Plan

• Start and end dates for the plan as well as any other important events and dates 

• Stock Option Plan documentation tends to be generated by legal professionals or along the guidelines provided by legal advisors

 

Conclusion

 

ESOPs are an invaluable tool for the modern enterprise. From long-time devotees such as

Microsoft to new startups, history dictates that a firm’s stakeholders can derive a long-term benefit

from these plans as they enable the recruitment & retention of talented staff, foster an

entrepreneurial environment and provide a mechanism for the alignment of interests between

employers & employees. Over time and in the wake of successful companies, these plans also

tend to build sustainable wealth for employees and their communities.

 

ESOPs represent an opportunity for companies to establish a relative advantage in an increasingly

competitive global marketplace. The flexibility available to a firm contemplating ESOP

implementation is also an important factor, as these plans should be tailored in order to support

the long-term strategy of the enterprise. While these plans typically come at a cost to both parties,

be it dilution and out of pocket expenses for the employer or lower cash compensation and an

illiquid investment for the employee, the overall benefits of such plans have been historically shown

to outweigh the related costs for both stakeholder groups.

 

Tech Investor Network supports the implementation of Employee Stock Option Plans by its investee firms as the

prevailing belief that long-term enterprise value is driven by competitive advantage, employee

productivity and business plan execution, all of which are demonstrated effects of ESOP

implementation. 

 

Glossary of Terms

 

Employee Share Ownership Plan (ESOP): A plan established by a company whereby a certain number of shares are reserved for purchase by key employees. Such shares typically vest over a period of time to serve as an incentive for employees to build long term value for the company. Exercising Options: The company must make shares available at the previously agreed upon strike price when an employee wants to convert vested options into shares. The firm either buys shares from other shareholders or issues new shares. As options are exercised, the employee can either pay the company cash or make a “cashless” transaction by forgoing some other form of compensation in order to pay for the shares. Liquidity Event: An event that allows an investor to realize a gain or loss on an investment. Most common exit routes include company buyouts, Initial Public Offerings [IPOs] and buy backs. Option Pool: The number of shares set aside for future issuance to employees of a private

company.

 

Stock Cliff: The period of time between the grant date of a set of options and the date that the first allotment actually vests. For example under a grant of 1000 options that vest over 4 years, the first 25% may vest after a period of 12 months and after that an equal amount per month will be made available over the remainder of the 4 years. The first 12 months is what is known as the cliff, a mechanism intended to retain employees for at least that period of time.

Stock Options: A widely used form of employee incentive and compensation. The employee is given an option to purchase its shares at a certain price (at or below the market price at the time the option is granted) for a specified period of years.

 

Strike price: The price at which an option or warrant can be exercised. Also known as exercise price. Vesting Period: Option grants usually have vesting periods. This means that the holder’s ability to

cash in options for actual stock will grow over time or may be restricted until a certain future date. Companies often set a three to five year vesting period

Vesting schedule: The timetable for stock grants and options mandating that employees earn (vest) their equity stakes over a number of years, rather than upon conversion of the stock options. Such a s

 

Resources

For more information about ESOPs and stock option plans please review the following list of books

and websites.

 

Books:

Employee Share Ownership Plans: How to Design and Implement an ESOP in Canada by Perry

Phillips (Wiley and Sons)

Employee Ownership: The New Source of Competitive Advantage by Carol Beatty (Wiley and Sons)

 

Websites:

http://www.esop-canada.com/

http://www.nceo.org/

http://www.esopassociation.org/