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Grow + Sell Your Business Part Four: Employee Incentives

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Presented on 11/21 by Eric Duffee and Randy Gerber, Founder and Principal of Gerber LLC, as part of a four part series. This segment of the series covered equity-based employee incentives. It offered a clear description as to what they are, why companies use them, as well as some things to consider. Randy and Eric showcased a variety of examples along with a few alternatives in regard to compensation.

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Grow + Sell Your Business Part Four: Employee Incentives

  1. 1. Equity-Based EMPLOYEE INCENTIVES
  2. 2. WHAT ARE THEY?
  3. 3. Compensation tied to equity value Actual equity “Synthetic equity”
  4. 4. WHY DO COMPANIES USE THEM?
  5. 5. Attempt to align employee incentives with owner incentives Provide additional compensation to attract and retain quality talent when cash is scarce Use of vesting/forfeiture as retention tool
  6. 6. WHAT ARE THE CONSIDERATIONS?
  7. 7. Effect On Owner Employee Behavior Tax Impact Employee Cost
  8. 8. WHAT ARE THE OPTIONS?
  9. 9. Incentive stock options Nonqualified stock options Equity grants Restricted equity Profits interests (tax partnerships only) Actual Equity
  10. 10. Phantom stock SARs Synthetic Equity
  11. 11. EXAMPLE
  12. 12. Mr. Burns wants to grant an equity award to Smithers to help incentivize him to build profitability at the Springfield Nuclear Power Plant. He decides to give Smithers 10% of the company. How should he do it? Example: Mr. Burns wants to grant an equity award to Smithers
  13. 13. Incentive stock option (if corporation): Smithers pays the fair market value at the time of grant in order to exercise the option No tax at time of grant No tax at time of exercise Capital gains upon ultimate sale (assuming waiting periods are met) Example: Mr. Burns wants to grant an equity award to Smithers
  14. 14. Nonqualified stock option: Smithers pays the fair market value at the time of grant in order to exercise the option No tax (generally) at time of grant Taxed at ordinary income rates at the time of exercise Capital gains upon ultimate sale (assuming waiting periods are met) Example: Mr. Burns wants to grant an equity award to Smithers
  15. 15. Equity grant: Smithers pays nothing for the stock Taxed at ordinary income rates on the full value of the stock Capital gains upon ultimate sale (assuming waiting periods are met) Example: Mr. Burns wants to grant an equity award to Smithers
  16. 16. Restricted equity— vests 25% per year over 4 years: Smithers pays nothing for the stock Smithers is taxed at ordinary income rates on 25% of the value each year Capital gains upon ultimate sale (assuming waiting periods are met) Example: Mr. Burns wants to grant an equity award to Smithers
  17. 17. Profits interest (if partnership): Smithers pays nothing for the equity Smithers is not taxed at the time of grant or at vesting But Smithers only receives 10% of future appreciation in the equity, not any of the existing equity value Capital gains upon ultimate sale (assuming waiting periods are met) Example: Mr. Burns wants to grant an equity award to Smithers
  18. 18. Phantom stock: No cost to Smithers Smithers receives cash payment equal to 10% of the outstanding company stock Taxed entirely at ordinary income rates Not paid unless/until directed in the agreement No rights as an equity owner Example: Mr. Burns wants to grant an equity award to Smithers
  19. 19. SAR: No cost to Smithers Smithers receives cash payment equal to 10% of the future appreciation in the equity, but nothing for current equity value Taxed entirely at ordinary income rates Not paid unless/until directed in the agreement No rights as an equity owner Example: Mr. Burns wants to grant an equity award to Smithers
  20. 20. DO THEY WORK?
  21. 21. WHAT ARE THE ALTERNATIVES?
  22. 22. Salary Bonuses/ Incentive Compensation Deferred Compensation
  23. 23. Eric D. Duffee Kegler Brown Hill + Ritter eduffee@keglerbrown.com keglerbrown.com/duffee 614-462-5433 Investment advisory services offered through Gerber, LLC. Gerber, LLC is not a registered broker/dealer and is independent of Raymond James Financial Services, Inc. Securities offered through Raymond James Financial Services, Inc. Member FINRA/SIPC. Raymond James is not affiliated with and does not endorse the opinions or services of Todd Kemmerer, JR Kern, Capitol Equities, or their respective representatives. Randall Gerber is a registered representative with Raymond James Financial Services. Neither Raymond James Financial Services nor any Raymond James Financial Advisor renders advice on tax issues, these matters should be discussed with the appropriate professional. Randall T. Gerber Founder, Gerber LLC/ Lead Advisor, RJFS randall.gerber@gerberclarity.com gerberclarity.com/randy-gerber 614-431-4343

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