Stocks: An Overview
Own stock – work for yourself. Employers often want employees, especially executives, to think like company owners. The best way to do that: issue stock, options to purchase stock or other forms of equity equivalents, such as phantom stock.
While equity and there equivalents vary significantly to both companies and executives, most have advantages obvious for all parties: companies gains employees motivated to improve overall company value and employees receive added compensation for their work.
Yet, equity contracts and grants often remain convoluted. Each is different, and it is important to thoroughly read through the details in plans and granting documents, especially checking strike prices, vesting provisions, acceleration clauses, claw backs, expirations, benefits, and exercise restrictions.
The most common types of equity grants are as follows:
- Incentive stock options (ISOs) are among the most common form of equity granted to employees. They may only be granted to certain individuals, and they are the only equity option that offers particularly favorable tax treatment – capital gains tax rates upon sale, with no tax due upon exercise – so long as a number of prerequisites are met. The classic formulation of an ISO is an option to purchase stock at a particular per share price some point in the future. These grants usually vests over time, with the first slug vesting after twelve months (the cliff), and the remaining, on a quarterly basis over three years.
- Non-qualified stock options (NQSOs) are similar to ISOs but without the favorable tax treatment. This means typically that the employee is taxed upon exercise of the option at ordinary income tax rates, as opposed to capital gains rates upon sale. This usually results in individuals buying and selling stock on the same day to cover taxes, as opposed to clearing the twelve month holding period to reach long term capital gains rates.
- Stock Settled Appreciation Rights (SSARs) grants an employee payment in stock. The payment is equal to the amount which the value of stock has increased since the employer-employee agreement was made.
- Phantom Stock is similar to SSARs, but the employee is paid in cash instead of stock. The payment is still equal to the amount which the value of the stock has increased, but the employee receives no actual stock.
- Restricted Stock Grants are a fixed amount of shares that are given to the employee that are subject to a right of forfeiture or repurchase by the company. That right lapses over time, much like vesting.
- Restricted Stock Units (RSUs) is when an employee is granted stock to be paid at a specified date in the future. These are also subject to forfeiture or repurchase by the company. RSUs are usually used by newer companies looking to grow.
Wrongful cancellations of employee stock options and grants, breach of option agreements or wrongful termination of options are often sufficient grounds for legal action. But knowing exactly what type of equity that your company offers to you is crucial, both to know what you’re getting and to understand if the company has breached its agreement. As you can see, each type of stock comes with its own set of rules that an employer must abide to, each of which results in different benefits to the employee. If you are negotiating for one of these grants, believe your company has breached one of the rules or you believe you’ve earned equity you never received, please contact us today.
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