Equity Incentives by Herb Moore

1. Options to Attract, Retain and
Incentivize Talent
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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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