Equity Grant: Everything You Need to Know
An equity grant, also referred to as equity compensation, is a non-cash payment provided to someone. 5 min read
Equity Grant: What is it?
An equity grant, also referred to as equity compensation, is a non-cash payment provided to someone. Essentially, the receiver is being granted equity in something.
Equity Incentives to Employees
Today, many companies are continuing to search for new ways to both motivate and compensate its employees without using cash. Some companies are responding to this challenge by providing equity awards or stock to its employees to keep them happy. While many companies already have something in place for a number of employees, those companies out there that don’t currently have it set up are now looking to do so.
However, granting equity to employees can raise several issues, including legal, tax, corporate, and contract implications for both the employer and the employee.
Issue #1: Will the Equity Grant be Given Under an Employee Plan?
Although some companies grant equity on an informal basis to its employees, most companies offer stock options under the employer plan, which is subject to the approval of the company’s board of directors and, at times, the company’s shareholders too.
These plans, also referred to as stock option plans, equity incentive plans, or stock incentive plans, explain in detail the type of equity offered, the maximum number of shares being provided to the employee, and the guidelines relating to the grant.
Be mindful that equity plans are not the same as employee stock ownership plans, which are tax-qualified employee benefit plans that buy and hold employer stock for the benefit of the plan participants.
Issue #2: What Type of Equity Grant Will I Receive?
Generally, equity is granted in the following ways:
- Written agreement
- Direct grant of stock, specified in the employee’s contract of employment
- Option, which is an option to purchase the employer’s stock in the future for a specified price
- Phantom stock, which is a bonus provided to the employee that is based on the value of an employer’s stock on a future date
Issue #3: How Do Securities Laws Apply to my Equity Grant?
Generally, federal and state securities laws require that the sale of stock, or other similarly situated securities, be registered with the Securities & Exchange Commission (“SEC”) as well as any relevant state securities agencies unless the offer itself fits into one of the statutory or regulatory exemptions. This principle applies for equity grants too. With that being said, an exemption almost always exists when a company offers options or stock to employees.
Publicly held companies generally file an S-8 Registration statement with the SEC to register such employee equity grants. However, if the company chooses not to file this form, the equity grant must be structured in a way to avoid registration. While it may seem as though a company is acting unethically by trying to fit within a registration exemption, it is perfectly normal for in-house counsel and senior management at the company to find exemptions to avoid the hassle and paperwork of filing with the SEC.
Issue #4: Will the Equity Vest?
Yes. Most equity grants will vest at some point in time. Vesting simply means that the right given to you is now a right that you can take freely without any conditions. Generally, the employer will require that the employee remains with the company for a specific period of time before the equity will vest. Once the equity has vested, however, the employee can leave the company without losing any financial compensation that was gained while employed with the company. Therefore, the benefit is fully vested.
Take, for example, a business that provides its employees with 1 percent of the company’s shares. Now assume that the company has a five-year vesting period. Therefore, if an employee leaves the company before the five-year mark, he will lose his 1 percent interest in the company. However, by year six, he can leave the company for another opportunity, and still own 1 percent of the company.
Issue #5: How Much Equity Will I Receive?
The one thing you should know about the equity grant that was provided to you is the percentage being offered. Simply put, how much of the company are you being granted? The number of shares doesn’t necessarily matter, but the percentage does in fact matter. Make sure that, before joining a company, management advises you of the percentage.
Issue #6: When Does the Grant Expire or Terminate?
If you receive an option, the option agreement will provide an expiration date, at which point in time that option can no longer be exercised.
If you receive an equity grant, the agreement will provide dates regarding when the grant vests, the percentage, and number of shares.
Issue #7: Is it Taxable?
This answer depends on what type of equity is being granted.
Yes, unrestricted stock is taxable. The amount taxed is the fair market value of the equity received, even though the employee doesn’t have the cash in hand.
No, restricted stock is not taxed until the equity vests. Therefore, if the fair market value of an employer’s stock increases annually, so too will the employee’s tax liability. In this case, you as the employee could file IRS Section 83(b) within 30 days of the grant. This form requires the employee to pay taxes on all unvested restricted shares based on the fair market value of the shares at the time the equity is granted. Therefore, the employee will not have to pay taxes on the vested amount, which would be considerably higher as the fair market value is expected to increase over time.
If the option has an exercise price equal to the fair market value of the stock at the time of the grant, then the employee will not be taxed the same year that the grant is given to the employee. But, once the option is exercised, the employee will be taxed on something called the spread. The spread is the difference between the exercise price and the value of the shares at the time the option is exercised.
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