1. Equity Compensation
Using Stock and Options to Pay for Services
12.17.14
Benjamin M. Hron
bhron@mccarter.com
617.449.6584
@HronEsq
2. OVERVIEW
♦ Pros/Cons of Equity Compensation
♦ Vesting
♦ Types of Equity Compensation
♦ Mechanics of Grants
♦ Taxation
♦ Other Common Terms
♦ Advanced Concepts
♦ Allocating Equity Compensation
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3. PROS/CONS OF EQUITY COMPENSATION
♦ Pros
– Reduces cash burn rate
– Aligns incentives
♦ Cons
– Complicate compensation & capitalization
– Potential to overpay (ex. David Choe)
NOTE: Equity is NOT a substitute for min. wage
federal & state labor laws apply!
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4. VESTING
♦ Vesting = lapsing of restrictions on ownership
– over time (typically 4 years)
– upon achievement of milestones
♦ Acceleration
– On termination
– On change of control (single v. double trigger)
♦ Critical for controlling capitalization
♦ Aligns incentives
♦ Aids in retention (golden handcuffs)
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5. TYPES OF EQUITY COMPENSATION
♦ Stock (restricted v. unrestricted)
♦ Options
– Incentive Stock Options (ISOs)
– Nonqualified Options (NQOs)
♦ Others (not common for startups)
– Stock Appreciation Rights
– Phantom Stock
– Restricted Stock Units
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6. MECHANICS OF GRANTS
♦ Board (& Stockholders?) approve a “Plan”
– Stockholder approval required to grant ISOs
♦ Board approves price & amount in advance
– Price > FMV
Required for ISOs
For other grants, price ≤ FMV TAXES
– Board usually also approves vesting schedule
♦ Securities law compliance
♦ Grant must be made promptly
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7. TAXATION
♦ Timing of income recognition
– ISOs & NQOs
– Stock
– 83(b) election
30 days to file – NO EXCEPTIONS
♦ Ordinary Income v. Long Term Capital Gains
♦ 409A Excise Tax on Deferred Compensation
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8. TAXATION
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Grant
Date
Vest
Date 1
Vest
Date 2
Vest
Date 3
Vest
Date 4
Exercise
Date
Sale
Date 1
Sale
Date 2
T=0 T=6mo T=12mo T=18mo T=24mo T=30mo T=36mo T=42mo
ISO No Tax No Tax No Tax No Tax No Tax No Tax OI =
# x gain
LTCG =
# x gain
NQO No Tax No Tax No Tax No Tax No Tax Ord Inc = #
x spread
OI =
# x gain
LTCG =
# x gain
RS w/o
83(b)
No Tax OI =
# x spread
OI =
# x spread
OI =
# x spread
OI =
# x spread
N/A CG =
# x gain
CG =
# x gain
RS w/
83(b)
Ord Inc =
# x spread
No Tax No Tax No Tax No Tax N/A CG =
# x gain
CG =
# x gain
Spread = FMV - Cost
Gain = Sale $ - Basis
9. OTHER COMMON TERMS
♦ Voting obligations
♦ Restrictions on transfer
♦ Company right of first refusal on transfer
♦ Co-sale (“Tag-along”)
♦ Drag-along
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10. ADVANCED CONCEPTS
♦ Choosing appropriate type of incentive
♦ Quoting grant in # v. %
– Outstanding Shares v. Fully-Diluted Capital
♦ Repurchase of vested shares
– Termination for Cause or w/o Good Reason
– Other
♦ Vesting v. Exercise (CA-style options)
♦ Refresh grants
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11. ALLOCATING EQUITY COMPENSATION
♦ Setting option pool size
♦ Considerations in setting grants
– Value add
– Cash compensation
– Competition
– Precedent
♦ PLAN AHEAD
– Hiring needs
– Refresh grants
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