 |
 
 |
 
|
 |
|
Stock Options Other Incentives For The Emerging Company
As a growing, middle-market business
law firm, we represent many aggressive
start-up businesses - founded by entrepreneurs
who see big potential and a clear exit
scenario in the form of an initial public offering,
corporate buy-out or the like. In order to
get there, they need to bring aboard other
bright, aggressive people who will want a piece
of the action. This article is a very brief summary
of the more common alternatives.
Non-Statutory Stock Option.
This is perhaps
the simplest form of stock option. It provides
to the recipient the right to buy a specified
number of shares at a specified price over a
specified period of time and under specified
conditions. Assuming that it is set up properly,
there are no tax consequences to the company
or the recipient until the option is exercised, at
which time the recipient will have ordinary
taxable income equal to the excess of fair market
value at the time of the exercise over the
exercise price. The company will have a corresponding
deduction.
Incentive Stock Option ("ISO"). This is
substantially similar to the non-statutory stock
option, except that the ISO is subject to various
restrictions and may be granted only to a person
who is legally an employee of the company.
The ISO is more tax advantageous to the recipient
(and less so for the company) in that there
is no taxable event when the recipient exercises
the option. When the recipient ultimately sells
the stock, any gain is taxable at capital gains
rates. The company has no deduction.
Restricted Stock Award. A restricted stock
award is a conditional "gift" of stock in the
company which will have a "substantial risk of
forfeiture" if specified events do or do not happen
over a specified period of time. The advantage
of the restricted stock award is that the recipient
is typically entitled to vote the shares,
receive dividends and otherwise exercise the
rights of a stockholder from the beginning. Assuming
substantial risk of forfeiture, the recipi-
but, at the time the "substantial risk of forfeiture"
goes away, the recipient will have to pay tax on
the full fair market value of the stock at that time.
This can be a serious problem for the recipient,
who may have no right or ability to sell the
stock and yet be forced to pay state and federal
taxes, possibly in the neighborhood of 40-45%
of the full fair market value of the stock.
Phantom Stock.
This is an arrangement
whereby the employee or other recipient receives
a contract right to be compensated at
some time in the future on a formula intended
to mirror what the person would have received
had he or she actually owned stock and sold it.
There are no rules or set format for phantom
stock arrangements; they tend to be customized
for each company. The tax rules are simple:
whenever the payout is received, it is treated as
a cash bonus and taxable as ordinary income.
Stock Purchase Plans.
This arrangement
allows employees and others to purchase company
stock at something approximating fair
market value. Assuming a purchase at fair market
value, there are no tax consequences up
front. The recipient is taxed at capital gains
rates when he or she sells the stock. The primary
disadvantage of this plan is that it requires
the recipient or other person to come up with
real, hard cash at a time when the value of the
company may still be speculative.
Accounting Treatment.
The accounting
treatment for stock compensation programs has
become somewhat complex and remains in
flux as of the writing of this article. For businesses
contemplating a public offering within a
three-year time frame, or for whom "GAAP"
earnings are otherwise important, we recommend
consultation with a skilled accountant
before establishing a course of action.
Caveat.
The foregoing is a much-simplified
description, intended only to provide a framework
for further understanding. The granting
of stockholder status to employees carries implications
which may not be appropriate in
many situations. We urge our clients to consult
with us before making any decisions with regard
to stock compensation plans.
|
|
|
|
|
 |
