In addition to, or as an alternative to, stock options, companies can also use one or more of the forms of stock-based compensation as a way of providing long-term incentives. Stock-based compensation can give the employee a vested share in the company, allow the employee to share in the benefits that the company derives from his or her services, yet not directly dilute the ownership and control of existing management. Further, if done properly, many of the concerns of securities regulation may be avoided. There are several forms of stock-based compensation available to companies. Three of the more common ones are:
A Stock appreciation rights, which give employees a long-term incentive by the future receipt of either cash or stock in an amount keyed to the appreciation in value of the company's stock over a specified time period;
A Phantom stock arrangements, which allocate hypothetical shares of stock to employees (depending on the terms of the plan, the phantom stock may be converted at a later date to actual stock, cash or a combination of the two); and
A Performance incentive compensation plans, which reward executives with stock and/or cash based on corporate or personal performance achieved over a specified time period.
Normally, these plans are used for executives and key employees, but nothing prevents them from being used with all employees. In order to remain forward-looking and competitive a corporation must attract, motivate and retain highly-skilled and experienced employees. For this reason, it is not unusual for a corporation to devote considerable managerial and staff time in designing innovative incentive programs. The corporation may use these programs to create an atmosphere in which employees feel they have a stake in the growth of the company.
Even though equity ownership through stock options may be the goal of many corporate employees, corporations can compensate employees as if they were shareholders without actually giving them shares or the opportunity to purchase shares through stock-related devices such as stock appreciation rights, phantom stock, or performance units, or a combination of them.
As indicated in the accompanying articles dealing with the various state and federal securities exemptions, it is necessary to either register all securities, or there must be an exemption from registration available. To avoid dealing with these issues, a privately held company may choose to use stock-based compensation. This also has the additional advantage of protecting the shareholders' ownership interests from dilution.
Each of these plans may be designed to reward corporate and individual performance. The plans pay the employee with cash and/or shares of stock if performance standards are achieved over a prescribed time period. The standards can be both objective and subjective. A stock-based plan typically sets forth:
A The performance benchmarks;
A Employee eligibility for participation; and A The total number of shares available under the program.
Companies can also use performance cash plans that pay employees a dollar amount measured by performance, if the desired benchmarks are achieved. Owners that want to prevent share dilution may want to consider performance cash awards over performance share or unit compensation arrangements. Companies that have concern that they cannot bring their stock sales to employees into securities law compliance can also use such programs. If stock is not granted, there is no practical difference between the stock-based plans.
Tax effects
The IRS treatment of stock-based plans is relatively uncomplicated. The IRS taxes the employee when the company pays the employee the cash related to the stock-based program. The corporation then takes a like deduction for the amount paid in the year in which it is paid and withholds the applicable amount from the payment.
Please see the following articles for additional information: Employee Stock Option Plans, Tax Aspects of a Stock Option Plan, Federal Securities Aspects of a Stock Option Grant, Option Plan Decisions, Stock Appreciation Rights, Phantom Stock, Performance Units, Non-Qualified Deferred Compensation Plans, Texas Exemption for Employee Stock Option and Similar Plans.
THIS INFORMATIONAL MEMORANDA FROM THE LAW OFFICES OF THOMAS D. SOLOMON, P.C. is provided as a courtesy to our friends and clients to provide them with items of interest in the stock option area. It is not and is not intended to be an exhaustive treatment of its subject matter, but rather an overview of some of the pertinent elements of such matter. It is not intended to be legal advice or a legal opinion and should not be relied on in making legal or business decisions. If you have any questions, please call us.
