No Longer at Equity

Image: Marlene J. Viola Look for big changes in the stock options that lure many scientists out of academia and into the biotechnology industry, life sciences compensation analysts say. The stock market decline has stripped options of their value, just as regulators have begun to eye them suspiciously. Seemingly obscure accounting issues are critical to scientists in biotech firms, who may have gambled half their pay package on options or on rights to buy shares in a company at a set price. "Gone are the days when people thought they would become millionaires or multimillionaires," says Jack Dolmat-Connell, who counsels companies on compensation in life sciences for Clarke/Bardes Consulting in Boston. Scientists at many biotechnology firms are learning the hard way that options are a gamble, as is the business of creating new technologies. "Options sometimes work, but not always," says Bob Gore, a principal with Towers Perrin's Boston office, who says the biotech industry is the "most aggressive" user of stock options to lure and keep talent. A study by Clarke/Bardes last spring looked at the use of options by 109 biotech, medical instrument, and pharmaceutical firms.1 Biotechnology firms handed out more options as a percentage of outstanding shares, 3.53%, than did medical device firms, at 3.42%, or pharmaceutical firms, 2.03%. The ratio of options, or rights to buy shares, to the number of shares outstanding indicates the equity employees could choose to buy at a discount. "Today if you join a biotech organization, your cash compensation is going to be competitive, reasonable," Gore says. "But the real play is in the equity." Equity formerly meant options, and it was a significant chunk of a biotech scientist's compensation package. The analysts predict that biotechs will use different forms of equity to entice scientists out of academia. "In the future, we may see more grants of restricted stock, which vest over three to five years," Gore says. Unlike options, which have no value until they are swapped for shares of stock, grants of restricted stock do have some value, even if the company is not doing well. In recent years, everyone from the founder to the newest lab technician has received options. Dolmat- Connell predicts the practice will end, thanks to regulatory pressure on companies to deduct the cost of options from their revenues. Companies that must disclose to shareholders the offering of discount buying rights, which is another way of looking at options, are not likely to make them available to most of the work force. US securities regulators are also moving to force companies to report their grants of options as expenses, which would then be deducted from revenue in calculating income. This practice is called the expensing of options. Current law allows companies to hand out options without expensing the cost until the options are exercised, when employees buy shares at a discount. The expected change in accounting may mean the end of option packages for rank-and-file working scientists, Dolmat-Connell predicts, as companies reserve the equity benefit for top levels of management. "If stock options broadly have to be expensed, then what will essentially happen, we believe, is the broad-based options plans that we know today will cease to exist," Dolmat-Connell says. Since many biotech stocks have been hammered in the market slide of the past several months, many scientists may not be too disappointed to learn that cash may come back in style in pay packages. Options gain value as the stock price rises. When the stock price drops, however, biotech employees are stuck with options that are said to be "underwater," meaning it would cost more to exercise the option and transform it into a share than it would to buy a share on the open market. These days, options in dozens of biotech firms are 'sleeping with the fishes,' rendered worthless by collapsing stock prices. Companies struggling to survive are selling off shares to new investors, diluting the value of the options in employees' hands. Mergers can mean cash-outs for options, but at bargain-basement prices. "If you look at the current market conditions for most biotech companies, options that have been granted within the past three years or so have no intrinsic value at this point," says Jeremy Pittman, a compensation consultant with Towers Perrin. The mechanics of options, however, make this a good time to get new ones. Since options are usually valued at the market price on the day they are granted, today's sorry stock market means scientists who stick around for the big payoff will gain a bigger profit margin. A scientist who was given 100,000 options to buy shares of his company's stock in 2000, when it was selling for $85 per share, has an exercise price of $85. His company's stock may well be valued at $20 per share now, so his option entitles him to pay $85 for something he can buy on the open market for $20. Not much of a benefit. But a scientist who joins the same company today and receives 100,000 options is given the right to buy 100,000 shares at $20 per share. If the price rises only $2 per share between now and the time the options vest, he stands to make a profit of $200,000. "Options are perceived as less valuable these days," says Dolmat-Connell. "It's interesting, because they are almost more valuable today because market prices and company valuations are so depressed, there is a lot more upside potential." Peg Brickley (dbizpeg@hotmail.com) is a freelance writer in Philadelphia. 1. Clarke-Bardes Consulting, "Cracking the Compensation Code, Executive Compensation and Stock Option Usage in the Life Sciences Industry," 2002.

No Longer at Equity

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