GRANTING EQUITY TO EMPLOYEES AND CONTRACTORS Curt P. Creely, Esq. Foley & Lardner LLP October 2012
Examples of Equity Grants: Grants of stock or membership units (generally granted in the form of restricted stock or restricted units or profit interests ) Options or warrants Stock appreciation rights (SARs) Restricted stock units (RSUs)
Is granting equity the answer? Pros: Aligns employee interests with owner interests Non-cash way of compensating employees and contractors Certain employees may expect equity May help attract high-quality employees
Is granting equity the answer? Cons: Employer equity often only has value upon sale of company or IPO Could be an expensive way to compensate employees Often doesn t result in the incentive effect Gives employees legal rights as stockholders or LLC members voting rights dividend/distribution rights inspection rights object of fiduciary duties Could involve unanticipated tax issues Administrative burdens
Have non-equity alternatives been considered? Phantom Stock Restricted stock units Bonuses contingent on liquidity event
General approaches to granting equity: Umbrella equity incentive plan with individual awards (generally appropriate for larger companies) Individually tailored awards (better when pool of grantees is relatively small)
Provisions that protect an employer s expectation Vesting / forfeiture restrictions can be time based or based on individual or company performance Expiration date Early termination No further vesting Some early termination events might even terminate a vested option Examples for early termination triggering events: termination of employment/service change of control or other corporate events post-employment misconduct (i.e., violation of non-compete or confidentiality provisions)
Provisions that protect an employer s expectation (continued) Voting limitation (i.e., nonvoting equity or proxy) Transfer restrictions Absolute prohibition on transfer for limited period of time Right of first refusal (perhaps payable over time) Limits on transfers to specified parties or classes of people (i.e., no transfers to competitors; no transfers to entities if employer is an S-corporation) Repurchase rights Could be triggered by death, disability, or bankruptcy Could be triggered by other events, such as post-closing misconduct Could be triggered by sale of company or change-in-control Limitation of Equity Holder Rights (i.e. limitation on inspection rights or fiduciary duties)
Provisions that protect an employer s expectation (continued) Drag-along rights for employer Redemption right for employer option or stock can be redeemed by employer at any time for specified price can be used as a way to hedge the cost of equity grants if appropriately priced Post-termination obligations/covenants on part of employees non-competition clauses non-solicitation clauses confidentiality provisions non-disparagement clauses work product clauses with a tail cooperation clauses In LLCs, employee equity can be defined or customized in various ways to conform to employer expectations (i.e., granting profits interests to employees)
TAX ISSUES General rule for restricted stock/units: Direct grants of equity are taxable compensation income to employees in the year in which the equity vests. Amount of taxable income is equal to fair market value of the vested equity at the time of vesting minus the price paid, if any General rule for options: So long as the exercise price of an option is equal to the fair market value of the underlying equity on the date of grant, the grant and vesting of the option will not be a taxable event to the employee (although exercise of the option may be a taxable event)
GRANTING EQUITY TO EMPLOYEES AND CONTRACTORS Q&A Curt P. Creely, Esq.