Many businesses offer their employees stock options or grants of restricted stock in the business as part of the employee’s compensation package. The stock options or the restricted stock could serve as a signing bonus, or may be designed to serve as a retention incentive so that the employees are encouraged and incentivized to stay with the company, at least long enough for their stock options or restricted stock to vest. The purpose of such equity incentive plans it to reward employees for joining and staying with the company and for contributing to the company’s overall success.
Equity Incentive Plans
A company needs key employees to be successful, and equity incentive plans are a convenient and useful way to make sure that key employees contribute to the success of the business. An equity incentive plan can provide employees with a framework by which they can be incentivized to continue to grant their support to the successful growth and development of the company. The stronger and more profitable a company becomes, the more valuable the awards granted to employees under an equity incentive plan will be. An equity incentive plan usually lays out the details of the incentive program, providing a baseline set of terms for each award that is issued under the plan. For example, the plan may specify the length of service to the company required for an employee’s equity incentives to become effective (i.e. to vest). More specific terms of each award, such as an option’s strike price and number of shares to be issued, are found in the stock option or restricted stock grant awards themselves.
Legal Issues Associated with Equity Incentive Plans
Employers need to be aware that there are many legal issues that can arise in association with an employee equity incentive plan. It is important that employers understand the effects and legal implications that necessarily result from different equity incentive approaches to retaining and rewarding employees. Some common issues that arise with equity incentive plans include:
- Tax implications for employees. Depending on the type of incentive stock options that the employer chooses to use in the plan, there could be tax implications for employees. Employers and employees alike may be interested in understanding the tax consequences associated with the various forms of equity compensation, particularly 83(b) elections, which determine the date on which equity grants are taxed, and which must be made within 30 days of the grant date.
- Valuations of the employee equity stakes can be difficult for the employer to conduct. Employers will need to make sure that employees’ equity stakes are valued, and valuations are required at different times based on the type of equity interest that is given to the employees or when the equity stake is given to the employee. For example, employers offering stock options must make a “409A valuation” (named after Section 409A of the Internal Revenue Code) when the options are granted to ensure the strike price is not less than the then-current value of the options’ underlying common stock.
- Providing securities to employees may trigger securities regulation issues for the employer. Equity incentive plans can require that the employer consider any and all securities regulation issues that may be associated with providing employees with equity stakes in the company. Compliance is required for all regulations set forth by the Securities and Exchange Commission concerning granting options and restricted stock to employees, such as Rule 701 under the Securities Act of 1933.
Equity incentive plans can be immensely beneficial when it comes to retaining top talent at your company. Employees are given an opportunity to hold a stake in the business, which ideally should motivate them to strive to make the company a success. Employers may need assistance when it comes to developing an equity incentive plan for their employees, and consulting with an experienced business lawyer can help ensure that your company’s employee equity incentive plan satisfies all legal requirements and complies with all the necessary Securities and Exchange Commission regulations.