| By understanding the basics of Compensation Plans, | | | | Non-Qualified Stock Options. There can be certain tax |
| Packages and Structures, a company can effectively | | | | preferences to a Junior Stock Option Employee when |
| lay plans to help incentivize employees toward | | | | purchased through a Qualified Plan, yet issues of |
| achieving company goals. A well designed and | | | | Valuation, Lapsing Restrictions and Conversion should |
| implemented Compensation Program will pay for itself | | | | be considered by a tax professional.h. Goal: Junior |
| in increased company profits. Here are the significant | | | | Common Stock Plans is a very economical |
| areas of the business to consider and the applicable | | | | compensation structure for a Key Employee; yet |
| compensation strategies to consider. | | | | clearly incentivizes Employees to contribute to the |
| A. Ownership | | | | overall success of the Company. While Convertible |
| 1. Founders Stock Strategya. Issue convertible | | | | Preferred Stock and Junior Common Stock have |
| preferred stock to outside investors and reserve | | | | many common features, the goals of each are |
| common stock for founders and key employees.i. | | | | opposite:i. Convertible Preferred goal is to depress |
| Convertible Stock should have a liquidation preference | | | | value of regular class stock into which a secondary |
| large enough to eliminate the book value of the | | | | class will convert.ii. Junior Common Stock's goal is to |
| Company, and in subsequent funding rounds the | | | | depress value of the secondary stock class which will |
| liquidation preference of each stock class should be | | | | be converted to regular class. |
| increased to cover the current book value.ii. The | | | | B. Harvesting Value: Rule 144 Implications |
| Convertible Preferred Stock should have Senior | | | | 1. Founder's Stock is subject to Rule 144 Restrictions, |
| Dividend, Preemptive and Redemptive Rights; | | | | which sets standards and procedures by which |
| registration rights and rights of co-sale.iii. Holders of | | | | restricted and control stock can be sold. The rule |
| Common Stock own only the remaining Shareholders' | | | | specifies when, how and how much restricted stock |
| Equity after the convertible stock preferences has | | | | and control stock may be sold in the public market |
| been satisfied.iv. The Goal: The superior rights of the | | | | place by private company owners and is subject to |
| Convertible Stock, when combined with the probable | | | | the SEC's Securities Act registration rules. |
| profit loss of a new venture, will substantially reduce | | | | 2. Restricted Stock is stock acquired from a |
| the taxable fair market value of the Common Stock. | | | | Company which has not been registered with the |
| Founders and Key Employees can obtain Common | | | | SEC through a Private Placement. |
| Stock at significantly reduced prices and tax liabilities | | | | 3. Control Stock is stock owned by Company |
| than paid by outside investors. | | | | Principals who control the business affairs of the |
| 2. Stock Options Incentivesa. An Incentive Stock | | | | stock issuing company, which would include Officers, |
| Option Plan (ISO) provides employees with tax | | | | Directors, Major Shareholders and individuals who |
| preferable stock acquisition.b. There are many rules, | | | | influence Management Decision Making. |
| conditions and tax implications for an ISO, so the ISO | | | | 4. Changes: There have been substantial changes in |
| Designer should be knowledgeable with factors the | | | | Restricted Stock Transactions whereby Small Cap |
| IRS considers instrumental to a fair market stock | | | | Venture Funds have incentives to buy into small |
| valuation. Penalties can be severe for miscalculations.c. | | | | companies. The holding and sales periods have been |
| A Qualified Stock Plan is a fantastic way to attract | | | | significantly shortened. Please confer with a Tax |
| and keep talent, as long as, the design and use of | | | | Professional to measure any Rule 144 implications to |
| the program understands potential issues, such as the | | | | your Company's Stock Structure and Plans. These |
| Alternative Minimum Tax, Sequential Exercise Rule, | | | | changes to restricted stock holding periods have |
| Loans, Holding Period Requirements, ISO Exercise | | | | made this type of stock a lot more marketable, as a |
| Conditions, Stock Exchange and Fair Market Valuation. | | | | result, much easier to determine fair market value. |
| 3. Non-Qualified Stock Optionsa. Maybe good to mix | | | | 5. Implications: Expert counsel should be utilized when |
| with ISO plans for certain employees to balance tax | | | | designing your Company's Compensation Structure |
| implications.b. Excellent vehicle if want to grant an | | | | and Package to fully understand the extent of Rule |
| option to an Outside Director, Consultant, Adviser, or | | | | 144 regulations, penalties and implications. |
| Supplier.c. Issues to consider when utilizing a | | | | C. Returning Ownership: Termination Considerations |
| Non-Qualified Stock Option Plan include Inadvertent | | | | 1. A Company needs to be protected against |
| ISO Qualification; Institute withholding, Shareholder's | | | | founders, key personnel and major shareholders |
| Grants, Loans and Valuation Methods.d. | | | | departing, to include disability, termination and death. |
| Considerations: In some situations a Non-Qualified | | | | 2. Buy/ Sell Agreements help a company retain the |
| Option can be more advantageous over an ISO; | | | | ability to recapture the value of stock and ownership, |
| however, an ISO has a lower tax burden at exercise, | | | | normally through the use of insurance policies to fund |
| and the time value of money is superior. Also, | | | | the Buy/ Sell Agreement. |
| long-term capital gain implications are often better | | | | 3. A Buy/ Sell Agreement will protect the |
| tempered through an ISO. Again, it is very important | | | | entrepreneur's return on his or her efforts. |
| to hire experts in this area to fully explore Qualified | | | | 4. Other forms of protection are utilized through |
| and Non-Qualified Stock Option Plans. | | | | Vesting Programs for Stock Options and |
| 4. Subordinated Common Stocka. Junior Stock can | | | | profit-sharing plans. As a Company matures and |
| allow key employees of startup firms or high growth | | | | achieves success, vesting plans can secure key |
| companies to acquire a subordinate class of Common | | | | employee loyalty while maintaining adequate |
| Stock at a fraction of the value of regular class | | | | incentives to excel and increase company profits. |
| Common Stock.b. Have an option to possibly convert | | | | D. Conclusions |
| into the regular Common Stock.c. This stock | | | | 1. A company's choice of Compensation Structures |
| structure awards key employees from substantial | | | | and Programs should reflect both its ability to reward |
| improvements in the Company's Sales and Earnings.d. | | | | and incentivize employees and affect the company's |
| The associated rights of Junior Stock conveys | | | | future growth. |
| inferior rights to those of regular Common Stock, | | | | 2. Typically, Founder's Stock, an ISO and |
| such as, reduced voting and dividend rights, and | | | | Non-Qualified Stock Option Plans are often best |
| inferior liquidation preferences.e. However, if the | | | | suited for early stage companies, while Junior |
| Company achieves specified Strategic Goals in Sales | | | | Common Stock Plans may be more appropriate for |
| and Net Income, the Junior shares convert to regular | | | | recent IPO companies or later stage private |
| shares on a one to one basis.f. Junior Stock Plans | | | | companies. |
| should restrict ownership of shares to continuing | | | | 3. Experts in tax, accounting and compensation |
| company employees and include transfer limitations, | | | | structure, regulations and laws should be sought as |
| repurchase provisions and rights of first refusal.g. | | | | laws governing compensation structure and package |
| Junior Stock can be offered through an ISO or | | | | design and implementation change constantly. |