2. The information contained in this outline is
general in nature and based on authorities that
are subject to change. It is not intended, and
should not be construed as, legal or tax advice
provided to the reader. This material is not
necessarily applicable to, or suitable for,
specific circumstances or needs.
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3. Attract, retain and incentivize individuals
Offer present and future employees a greater
stake in the success of the Company
More clearly align the interests of employees,
consultants and advisors with those of the
Company
Reward those whom the progress, growth and
profitability of the Company depends
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4. Equity incentives are typically granted pursuant to the
terms of an “Option Plan” or “Equity Incentive Plan”
that’s been approved by board and shareholders
We typically prepare an option plan when we organize
a new corporation; usually about 20-30 pages long
Plan creates an “option pool” – total number of
shares/units available for grant under the Plan
The Board (or a Board committee) is in charge of
administering the Plan and approving equity grants
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5. Three (3 ) main types of equity incentives that
can be granted with an Equity Incentive Plan:
Options
Restricted Stock
Stock Appreciation Rights (SARs)
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6. A word about LLCs:
Equity incentive plans are common/straight-
forward when dealing with a corporation
You can certainly have an equity incentive plan
with an LLC but just be aware that you will be
dealing with the world of partnership taxation
There are a number of tax issues that need to be
considered, e.g., partners cannot be employees
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7. Option: contractual right to buy equity in a
Company for a stated period of time at a pre-
determined price
An option enables a person to benefit from
increases in the Company’s value
Option holder does not enjoy the rights
associated with stock ownership (e.g.,
dividends, voting, etc.) until exercise of option
and purchase of equity
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8. Your “Option Plan” or “Equity Incentive Plan”
will lay out the framework for what kinds of
options the Company can grant
Read your plan and if you have questions, go
over it with your lawyer
You want to keep your cap table as clean as
possible and one way you can do that is by
adhering to the terms of your Option Plan
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9. Specific terms of a person’s option are usually
set forth in an Option Award Agreement
Options should vest over time or upon
reaching certain goals as the option holder
continues to work for the Company
Options typically terminate sometime after the
holder’s employment terminates with the
Company
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10. An ISO is a stock option granted to employees
only (not available for LLCs)
If certain requirements in the tax code are met:
No income tax when ISO is granted to employee
No income tax when ISO is exercised by employee
There is income tax if employee sells the stock for a
gain
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11. Must be granted to an employee (rather than a
consultant or non-employee director)
Exercise price must be at or above market price
(FMV) at the time the option is granted (must
be determined in good faith by the Board)
Option term cannot exceed 10 years
Cannot be transferred except in case of death
Plan must be approved by board/shareholders
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12. Stock acquired with an ISO that appreciates in
value gets the lower, more favorable long term
capital gains treatment if it is sold:
2 years after ISO is granted; and
1 year after ISO is exercised
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13. If employee sells the stock acquired with an
ISO either:
Less than 2 years after it was granted; or
Less than 1 year after it was exercised,
Gains will be taxed at ordinary income rather
than capital gains rate
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14. If an option does not meet the requirements for
ISO status, then it is a non-qualified option
Tax treatment is simpler, but less favorable to
the employee or consultant
Like ISOs there is no income recognition upon
grant of the option
Unlike ISOs there is income recognition upon
exercise
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15. The income that is recognized upon exercise of
a non-qualified option is treated as ordinary
income
When the stock is sold later, the individual will
have a capital gain or loss
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16. In addition to ISOs and non-qualified options,
Company can also grant restricted stock to
incentivize employees, consultants and
advisors
The term “restricted stock” means the shares
have been transferred to an individual but
must be returned if employment/service
terminates before they “vest”
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17. There is no income reported for restricted stock
until the year in which the stock “vests” –
meaning it is no longer subject to a risk of
forfeiture
FMV of stock on vesting date – minus amount
paid for stock (if any) = ordinary income
Unless holder has made an 83(b) election
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18. Individual can file an 83(b) election to
recognize income in the year the stock is
granted – prior to vesting – based on the FMV
on the grant date
When stock has little or no value on grant date,
income reported is relatively small amount
83(b) made so that a large portion of the
appreciation in the stock’s value is taxed at the
more favorable long-term capital gains rate
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19. The risk in making an 83(b) election is an
individual may report income that’s never
actually received if the individual leaves the
Company before the stock vests
If the stock has little or no value, risk is small
Election must be made within 30 days of
transfer
Must be sent to IRS and filed with individual’s
return
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20. SAR: right to receive a cash payment equal to the
difference in the price of the Company’s stock on the
date of grant and the FMV of that stock at a future date
Usually vest over time and/or upon reaching certain
performance goals; SAR holder is not a stockholder
SARs are taxed as ordinary income when the holder is
entitled to exercise the SAR – whether or not the SAR is
actually exercised
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21. Finally, companies that may not be ready to grant their
employees, consultants or advisors equity in the
Company, may want to consider adopting a cash
bonus plan
Certain valued employees can be eligible to receive
discretionary bonuses that are tied to a set percentage
of net income
Employee must remain employed to be eligible; bonus
payable at Company’s discretion in accordance with
usual accounting practices
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22. Companies have a number of choices when it
comes to equity incentives and bonus plans to
attract, retain and incentivize talent
Before you grant equity, make sure you have a
solid “Option Plan” in place that allows for awards
of:
Options (ISOs and non-quals if you are a corp)
Restricted stock
Stock Appreciation Rights
If you are not ready to grant equity, consider a
discretionary cash bonus plan
Beware of tax consequences of granting equity in LLC
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23. Herbert P. Moore, Jr.
www.SorinRand.com
hmoore@sorinrand.com
O: 732-737-7730
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