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【SmartHR創業者が語るストックオプションの光と陰】業界慣習の罠：退職・M＆A時には失効／いくら持っているか知らない問題／“悪魔のエクセル” オペレーションが課題【Nstock宮田CEO】

Stock Options Discussion

Kobayashi

As we’ve discussed, stock options are a great system. For instance, if a company reaches unicorn status with a valuation of 100 billion yen, and allocates 10% of that as stock options, that means 10 billion yen in potential returns will be distributed among employees. If the company has 200 employees, that’s a potential 50 million yen per employee. This system should be incredibly appealing, but sadly, only 40% of employees at SmartHR fully understood the value of their stock options. We need to create a society where people who contribute to a greater good receive a fair return. Otherwise, we won’t see a growth in new businesses, and the talent pool needed to grow these companies will remain shallow. We need to make stock options more attractive to potential employees, even offering options that don’t expire upon leaving the company.

Miyata-san, you’re the founder of SmartHR, one of my investment companies, but today you’re here in your capacity as the founder of Nstock. Could you briefly introduce yourself and Nstock?

Miyata

I’m Miyata from Nstock. Nstock is a wholly-owned subsidiary of SmartHR, established a year ago. I founded SmartHR ten years ago and launched the SmartHR business seven years ago. I handed over the reins about a year ago. During my time at SmartHR, I designed and implemented a stock option plan for our employees, but honestly, I don’t think we did a very good job. I felt this lingering unease. About a year ago, I realized this was a problem worth solving and that’s how Nstock was born. Nstock aims to improve the Japanese startup ecosystem by making stock options, RSUs, and other equity compensation tools easier to use, advocating for legal changes, and raising awareness.

Stock Options Overview

Since today’s topic is stock options, let’s quickly review what they are. In essence, a stock option grants the right to purchase company stock. This might sound trivial, since you could always buy stock. However, stock options come with specific conditions – they allow you to buy shares at a predetermined price, within a set timeframe. This predetermined price is called the “exercise price” and is set when the option is granted. While stock prices constantly fluctuate, especially after an IPO, the exercise price remains fixed.

Imagine the stock price rises after the option is granted. You have the right to “exercise” your option and buy the shares at the predetermined price, even if the market price is much higher. The difference between the market price and your exercise price represents your profit per share.

Kobayashi

So, it’s basically the number of shares multiplied by the selling price minus the exercise price, right? That’s a significant potential return for employees. But as you mentioned, there’s a certain level of complexity involved. Terms like “exercise price” and “grant resolution” aren’t commonly used. What specifically made you feel uneasy about the stock option implementation at SmartHR?

Miyata

The biggest issue in Japan is that stock options are typically forfeited upon leaving the company. Let’s say someone joins a small startup, taking a significant risk. If it takes 8 years for that company to IPO, and for whatever reason, they have to leave after 8 years, they lose everything. Unfortunately, this was the case with SmartHR’s initial stock option agreements. At the time, I genuinely believed this was the law. I used a template from a reputable law firm, assuming it was correct. It turned out this wasn’t a legal requirement, but rather a common practice.

Kobayashi

I’ve heard similar stories from friends. Someone might join as a key executive, contribute significantly for years, and hold stock options. Then, due to unforeseen circumstances, like a family emergency requiring their full attention, they have to resign. If the agreement states that options are forfeited upon resignation, they lose everything. This is especially frustrating if there were alternative options, like vesting based on board approval, but those weren’t clearly communicated.

Miyata

Exactly. And because stock options are often implemented early in a startup’s lifecycle, when legal expertise and oversight might be limited, these situations arise more frequently. Early-stage startups are busy building products, focusing on customers, and often handle stock option implementation as a side task. They rely heavily on templates, which might not be ideal.

Miyata

In SmartHR’s case, our first CTO, who was instrumental in our initial growth, left after about two years. Despite his significant contributions, he left with nothing. This was a recurring pattern, and it felt incredibly unfair.

Miyata

Another issue is that the initial stock option agreement at SmartHR, taken from a template, stipulated that options would be forfeited even in the event of an M&A. Imagine employees working hard, contributing to the company’s value, and then, due to a management decision to pursue an M&A instead of an IPO, they lose their potential reward. This is a major disincentive for M&As in Japan. Management would be reluctant to pursue an M&A if it meant forcing dozens, even hundreds of employees to forfeit significant financial gains.

Kobayashi

You mentioned that the operational aspect of managing stock options can also be quite burdensome.

Miyata

Absolutely. Startups often use stock options, while listed companies might use RSUs or other equity compensation tools. Combining different tools for maximum effectiveness requires significant operational effort, which many startups struggle with. This can lead to suboptimal solutions due to operational constraints.

Kobayashi

I believe many companies manage their stock options with a “super spreadsheet.” One person in the HR department manages this incredibly complex and important document. Even a small mistake, like an incorrect date, could have disastrous consequences, potentially disqualifying the options from favorable tax treatment.

Miyata

That’s right. A simple error could lead to a significant increase in taxes for the employee, sometimes as high as 35%. Imagine earning a 300 million yen return from stock options and then having to pay an extra 100 million yen in taxes because of a single mistake. The responsibility on that one person managing the spreadsheet is immense.

Miyata

And this isn’t just about money; it can impact an employee’s life in unexpected ways. They might be denied access to childcare or face increased childcare costs due to their suddenly higher income bracket. A reward meant to be celebrated becomes a burden.

Kobayashi

So, the very system designed to reward employees can inadvertently harm them due to complexity and potential for errors.

Miyata

Exactly. And this contributes to the perception that stock options in Japan aren’t as attractive as they should be.

Kobayashi

You mentioned that the government is taking steps to improve the situation.

Miyata

Yes, the “Startup 5-year Plan” includes several initiatives to improve the stock option landscape. For instance, the 10-year expiration limit for tax-qualified stock options might be extended to 15 years. This is crucial, as the time it takes for Japanese startups to reach IPO is increasing.

Kobayashi

But allowing employees to retain stock options even after leaving the company is a significant shift in mindset. Many founders see their company as an extension of themselves, and the idea of former employees, perhaps those who only stayed for a couple of years, remaining shareholders might be difficult to accept.

Miyata

I understand that sentiment, but if a company aims to grow and eventually go public, it needs to adapt to the idea of having external shareholders. Embracing this concept early on is essential. Moreover, I believe that making stock options more flexible actually benefits the company in the long run. Startups go through rapid phases of growth, and what makes an employee thrive in one phase might not be suitable for another. Allowing employees to leave and pursue opportunities that better align with their skills, while still retaining their stock options, fosters a healthy cycle of innovation.

Miyata

This also helps attract top talent. The startup landscape has changed. We’re now seeing people from established companies, investment banks, and consulting firms considering startup roles. But they also need to weigh the risks and rewards. Offering stock options that don’t expire upon leaving makes the proposition more appealing.

Kobayashi

Ultimately, it comes down to building a system that rewards contributions fairly. Attracting and retaining talent is crucial for the growth of the Japanese economy. And while a strong mission and a positive culture are important, we cannot underestimate the importance of financial incentives. We need to move away from the outdated notion that passion should be enough. People should be fairly compensated for their contributions.

Kobayashi

The situation in Japan is starkly different from that in the US. Google, with a market capitalization of 150 trillion yen, allocates 2% of its stock annually for employee equity compensation. That’s 3 trillion yen distributed among its employees every year. With a workforce of around 150,000, that translates to an average of 20 million yen per employee annually. This amount grows alongside Google’s stock price, further incentivizing employees and attracting top talent.

Kobayashi

Some Japanese CEOs might argue that their employees are driven by the company’s mission, not stock options. But that’s a flawed argument. No CEO would expect their employees to work for below minimum wage out of passion. We need to apply the same logic to equity compensation.

Kobayashi

Thank you, Miyata-san, for this insightful discussion.