Executive & Employee Equity Based Compensation
Attracting talented people is a key to success for any business. However, many young companies lack the funds to pay market rate to their employees, independent contractors and advisors. An alternative to cash compensation is the award of an equity stake in the business.
More established businesses may also wish to award equity stakes to their employees as a reward for past services and as a retention incentive. There are many equity compensation models available, depending on the structure of the company and its objectives. In order to achieve the desired result, these models require careful tax planning.
We regularly assist clients in developing equity compensation plans, including incentive stock option (ISO) plans, non-qualified stock option (NSO) plans, restricted stock awards, and restricted stock unit (RSU) plans, as well as the grant of profits interests in limited liability companies (LLCs).
Equity Compensation Structures
Endeavor Law’s founder, David Brabender, is an established equity compensation attorney, and as such he is very familiar with the various equity compensation structures currently being adopted by start-ups and small businesses. The two most common forms of equity compensation are stock options and restricted stock.
A stock option is a contract right issued by a corporation to an individual to buy a set amount of shares of company stock at a particular price within a specified period of time. The price at which the employee can buy the shares under the option is called the “strike” price and is established at the fair market value per share at the time the option is granted. Usually an employee can choose to buy the shares at the strike price at any time options are vested during the term of the option. There are two kinds of stock option programs: incentive stock options (ISOs) and nonqualified stock options (NSOs). ISOs are more tax advantageous to the recipient, however, under the Internal Revenue Code they may only be awarded to employees.
Restricted stock is another form of equity compensation typically granted by a corporation to employees, board members, advisors, independent contractors and consultants. The shares are “restricted” in that the shares are subject to forfeiture and tied to a vesting schedule. The shares vest over an established period of time, and the recipient (employee, advisor, independent contractor) must remain employed or in the service of the company during the vesting period. If the recipient of the restricted stock leaves the company he/she will forfeit his/her unvested shares.
Restricted stock provides the recipient with the benefits of ownership, such as the right to vote during the vesting period. However, the recipient cannot sell or dispose of the shares until the shares vest.
The taxation of stock options and restricted stock has some complexity. However, as a general statement, stock options are taxable to the recipient as of the date of exercise of the option and restricted stock is taxable to the recipient as of the date the shares vest. Frequently, recipients of restricted stock from start-ups will file an Internal Revenue Code Section 83 (b) election to accelerate the taxation day to the date of the grant on the assumption that tax burden will be much less on grant date then on vesting date. This assumption is based on the likelihood that the value of the restricted stock in a start-up will increase rapidly; however, this is by no means a sure bet.
At your initial consultation, David Brabender will guide you through the issues for your consideration, make recommendations based on your entities particular facts and draft the documents necessary to reflect your intentions.