Employee Equity Compensation:
How to Incentivize Your Employees without Burning Through Cash
August 27, 2014
Tim DuVall – Katz, Sapper & Miller
Erin Eberly – Katz, Sapper & Miller
Kristine Camron – Ice Miller
▪ A tool to attract, retain and motivate key employees with a future interest in the company▫ Typically key employees and executive management, but
can be all employees
▪ Most common types of stock options:▫ Incentive Stock Options(ISO)▫ Non-Qualified Stock Options(NQSO)▫ Restricted Stock ▫ Phantom Stock▫ Profits Interests
What Are Stock Options?
▪ Benefits▫ Preferential tax treatment to option holders▫ Pays only if price increases and a triggering event
▪ Issues▫ Valuation▫ Vesting▫ Pricing▫ Limits on preferential tax treatment per year upon exercise ($100,000)
▪ Taxes▫ Option is not taxed when exercised; could have AMT issues▫ No ordinary income if held for qualifying period, resulting in long term
capital gain▫ The company deducts only ordinary income portion
Incentive Stock Options (ISO)
▪ Benefits▫ Corporate tax deduction▫ Pays only if price increases and triggering event
▪ Issues▫ Valuation▫ Vesting▫ Pricing
▪ Taxes▫ Taxed as ordinary income when exercised▫ The company deducts ordinary income to option holders when
exercised
Non-Qualified Stock Options (NQSO)
▪ Benefits▫ Form of Deferred Compensation and Stock Award▫ Value whether company valuation increases or decreases
▪ Issues▫ Forced income recognition and taxability▫ Section 83b opportunities▫ Vesting
▪ Taxes▫ Taxed as ordinary income when vested unless Section 83b election
made▫ Timing of taxation is fixed based on vesting or Section 83b election
Restricted Stock
▪ Benefits▫ Deferred Compensation Plan▫ Each plan can be unique
▪ Issues▫ Vesting period▫ Triggering Events▫ Timing of Payments▫ Sec 409A
▪ Taxes▫ Taxed as ordinary income by the employee and deductible by the
company
▪ Used by corporations
Phantom Stock
▪ Benefits▫ Entitle the owner both to capital appreciation and future profits▫ Motivates key employees to grow the company while limiting the
downside▫ Not taxed when issued
▪ Issues▫ Valuation▫ Employee could receive taxable income allocation without receiving
distribution to pay the tax
▪ Taxes▫ Can be taxed at long term capital gain rate upon redemption or liquidation▫ Tax is paid on allocated income from K-1
▪ Used by partnerships/LLC’s
Profits Interest
▪ Entity Structure▪ Legal Documents▪ Stock Option Pools▪ Equity Compensation Pools
How to Get Started
▪ Plan Document▫ Eligibility ▫ Stock option pool▫ Terms of grant, including vesting, pricing, timing of payments▫ Valuation method
- Triggered by sale or separate equity raise- Determined by Board
▪ Operating agreement
Legal Documents
▪ A Reserve for future issuances▫ Size is defined by the plan document▫ Authorized vs. Issued▫ New option pools for new financing rounds▫ Diluted ownership
Stock Option Pools
▪ Voting vs. Non-voting Stock▪ Vesting vs. Forfeiture Provisions▪ Company Option/Obligation to Repurchase Upon
Termination Events▪ Acceleration of Vesting on Change of Control
Additional Considerations
▪ Tim DuVall – [email protected]
▪ Erin Eberly – [email protected]
▪ Kristine Camron – [email protected]
Questions?