Ten Questions to Consider Before Granting Equity to Employees
Granting employees equity can be a great way to reward and motivate
employees. Most employees will work harder once they have some skin in
the game. However, granting equity can be complicated and it's easy to
make mistakes. Before granting equity to your employees, ask yourself
these important questions:
- Is equity really the right choice?
sure you have a clear understanding of what you want to achieve.
Are you aiming for retention, compensation, empowerment or other
goals? There are multiple ways to grant traditional equity, and
there are alternatives to traditional equity, such as cash bonuses,
profits interests and stock appreciation rights. An alternative to
traditional equity may achieve your business objectives while
avoiding the inherent complications of making an employee your
business partner. If you're only thinking about one kind of "equity,"
you may be limiting yourself and may not achieve your goals.
- Are you making it too complicated?
an equity program is created, someone must be tasked with
administering it. And you have to pay for that administration. If
you're considering a complicated structure or would regularly make
exceptions to the rules of your program, step back and think about
what you're really trying to achieve. There may be a simpler way to
- What if things don't work out?
a disgruntled former employee as a shareholder can be a nightmare.
You need the ability to repurchase your equity from departing
employees, but check with an attorney to make sure the repurchase
mechanism works as expected, and that it is enforceable. Buy-outs
under these circumstances can be contentious and you want to make
sure you've followed appropriate procedures.
- Have you considered all of the tax consequences?
you grant equity that has value, or grant a stock option with a
strike price below fair market value, you've just saddled your
employee with a current tax obligation-even though the employee
does not get paid any cash. The tax code is full of complexities
dealing with equity compensation that can lead to adverse tax
consequences for the company too (e.g., forfeiting S-corp status,
withholding obligations, running afoul of ERISA rules, losing the
ability to properly claim certain tax deductions, etc.). Make sure
your program provides the expected benefit and not an unexpected
- Have you complied with securities laws?
people are unaware that granting equity to an employee is a
securities transaction governed by federal and state laws. If the
total annual value of compensatory equity granted to employees
exceeds $5,000,000, you will need to provide specific disclosures
to recipients. Additionally, many states have filing requirements
for equity grants of any value or size, and some states have
specific disclosure requirements or require the payment of a fee.
Check with a securities attorney to identify compliance requirements.
- Are you unintentionally giving employees rights you don't want them to have?
of traditional equity makes employees shareholders. Equity owners
in Minnesota companies generally have the right to review the
company's sensitive information, including board and shareholder
minutes, financial statements, and shareholder lists. They may also
get voting rights on matters important to the company, like
amending articles, merging or liquidating the company. Be sure you
have a clear understanding of these rights before the grant occurs.
- Does granting equity provide lifetime employment?
your company is closely held (generally 35 or fewer owners), an
employee who owns equity may assert that she is no longer an
at-will employee because the ownership of equity gave her a
reasonable expectation of continued employment. While you can
contract around this problem, you have to do so proactively and
- Have you protected yourself from having unwanted co-owners?
you may be willing to allow an employee to be a co-owner of your
company, you need to avoid unwittingly allowing an employee's
spouse, children, your competitor or an unknown third party to
become a co-owner. You should have strong restrictions on the
transfer of equity in the form of a restricted stock agreement,
buy-sell agreement, member control agreement or shareholder agreement. If you don't, your employee may be able to transfer the equity to a person you don't want to have as a co-owner.
- Have you contacted an accountant?
equity will impact your company's financial statements. You need
to work with an accountant experienced in equity grants to fully
understand that financial impact.
- Have you contacted an experienced business attorney?
is complicated. Do it right at the beginning and avoid problems
later. An experienced attorney can assist you in designing an
equity program that achieves your business goals, avoids tax
surprises, complies with securities laws and reduces the risk of
future disputes with your employees.
right, granting equity can be a great way to motivate and retain
employees. When done wrong, it can be a massive headache for your
company and create legal, accounting and tax problems. If you would like
any additional information, please contact Edward Culhane