Transfer of Shares to Employees
Offering employee stock options is quickly becoming a go-to strategy for a large number of companies, especially the ones in the tech industry.
Despite the tight economy these days, a large number of business owners are searching for ways to retain and attract quality employees. A great way to achieve this, particularly in start-up organizations with smaller payrolls, would be to transfer shares to employees. There are several benefits of providing this incentive or perk.
Shares to Employees
The trend of offering shares to employees is on the rise, with the number of ESOP and ESOP-like plans (profit sharing, stock bonus, defined contributions plans) increasing over the past years. From the period 2010-2018, the number of ESOP-like plans increased over 166% over the 8 year period, according to numbers provided by the National Center for Employee Ownership.
Why do Companies Offer Equity to Employees?
Offering employee stock options is quickly becoming a go-to strategy for a large number of companies, especially the ones in the tech industry. As mentioned earlier, companies do this to foster loyalty and attract talent. What’s most impressive about giving equity compensation to employees is that it benefits the workers as well as the company.
However, compensation programs based on equity have several complexities, especially when it comes to personnel, taxes, legal, and accounting related matters. This often complicates things, especially for new business owners. However, overcoming these issues provides business owners with loads of advantages.
Let us break down some popular advantages of equity compensation to determine whether or not your organization should consider it. Before we proceed, keep in mind that the advantages mentioned below, primarily apply to privately owned companies.
- Compensating consultants, advisors, and employees with stock options rather than cash helps conserve your organization’s money for important expenses. It would be fair to say that offering an employee stock option may be the only way for cash strapped companies to attract and retain talent.
- Equity programs are ideal for aligning the business’s financial interests with the employee’s financial interests. It provides employees an incentive to work hard for the company, as doing so could increase their stock’s value.
- Workers holding stock options mostly view themselves as more than employees, which makes them feel connected with the company’s overall interests.
Types of Equity Compensation to Employees
When planning to transfer shares to employees, it is worth noting that there are three main equity based compensation types offered to employees: Employee stock purchase plans, restricted stock, and stock options. The latter two are arguably the most popular option utilized by businesses owners.
Stock options are one of the most renowned equity compensation types. The best thing about stock options is that it gives employees the right to purchase a particular number of shares from the organization’s stock at a pre-determined price, referred to as, the “strike price” or “exercise” for fixed periods, often following the vesting period, which is a pre-set waiting period. In most cases, the span of vesting periods is around 2 to 5 years.
As far as options go, one of the best things about stock options is leverage. Since stock options provide shareholders with a higher number of options compared to other equity compensation types, there is a lot of upside potential.
Also known as restricted securities or letter stock, restricted stock is essentially company stock that you cannot transfer until you meet certain restrictions. These could be timing or performance related restrictions, some of which could be similar to stock options. It would be fair to say that restricted stocks are a type of bonus, awarded in the form of stocks rather than cash.
Restricted stocks are an excellent substitute for stock options, especially for executives because of the favorable income tax treatment and accounting rules. The two main restricted stock types are Restricted Stock Units and Restricted Stock Awards.
Employee Stock Options
Employee stock option plans present workers with the option to purchase a particular amount of shares from the company’s stock at a certain price known as “grant price”. This option has a vesting and expiration date and employees cannot exercise their options prior to these dates. Employee stock options are considered “in the money” only when the stock’s current market price is higher than the grant price.
Are you new to employee stock options and find its terminology to be confusing? If yes there is no need to worry, as mentioned below is a summary of some popular stock option terms.
- Expiration Date – The period employees must make use of their options. Otherwise, they will expire.
- Vesting Date – This is the date mentioned in the employee stock option plan that employees should refer to, in order to determine when they can exercise their options.
- Market Price – The stock’s current price. This value is also commonly referred to as the fair market value.
- Strike Price / Exercise Price / Grant Price – The particular stock purchasing price determined by the employee stock option plan.
How Employee Stock Options Work?
Let us understand how employee stock options work with the help of an example. Let’s say for instance, that on January 2nd, 2018, you receive an employee stock option offering you to buy 1,000 shares for $10 per option. However, you must complete this by January 2nd, 2028. The stock reaches $20 per share in 2025 and you make the decision to utilize your stock options.
First off, you must purchase the shares for ten thousand dollars to utilize your options. You can do this in the following ways:
Send $10,000 to the firm taking care of the transactions. You will get 1,000 stock options in return, which you can keep or sell.
You utilize your stock option, selling enough stock that covers the initial price. Your brokerage firm will be taking care of this, leaving you with around 500 shares. So in theory you would be “exercising” your 1,000 options for $10,000 and selling 500 shares back to the company for $10,000. Therefore you would not own the company anything extra, and hold onto your remaining 500 shares.
There are plenty of other ways to exercise your stock options but these two methods are among the best and most commonly used by employees.
Different Types of Stock Options
- ISO – Also known as an incentive stock option, an ISO is essentially an advantage that offers employees the chance to purchase shares at lower rates with the extra benefit of tax breaks if they make a profit. The profit obtained on ISOs doesn’t get taxed for ordinary income; instead it gets taxed at capital gains rates.
- NSO – Non-qualified stock options or NSOs are employee stock options where you pay regular income tax based on the difference in price you choose to exercise the option and the grant price. NSOs are remarkably more common and simpler compared to incentive stock options. The reason why people refer to it as a non-qualified stock option is because it does not meet the Internal Revenue Code’s requirements.
Issuing Shares to Employees
The plan to transfer shares to employees could be mutually beneficial for employees as well as their employers. If you are planning to issue shares to employees, it is worth noting that while the process may seem straightforward, there are some intricacies that could complicate things. However, the steps mentioned below will prove to be more than handy.
Steps to Issue Shares to Employees
Issuing shares to employees takes many different steps that should be carefully planned before going through the process. Here are the steps to issue shares to employees in a company.
- Understand company’s goals – Is your company aiming for long term or short term profitability? What are its particular objectives? And, does it need an influx of talented employees to take it to another level? These are the questions employers need to ask themselves before deciding to offer equity compensation to employers. Understanding the company’s various goals could be a time consuming process, and you should take as much time as you want to make sure you don’t make hasty financial decisions.
- Choose an ESOP plan – Also known as employee stock ownership plan, an ESOP considers your company’s various needs. A large number of employers deduct their stock’s value on their taxes. On the other hand, employees can take center stage in their company, increase their stock’s value, and cash out whenever they decide to leave or retire.
- Decide how much shares you plan to give away to employees – Employers must determine the amount of shares they plan to offer employees. A lot of business owners prefer to keep over 50% of their company’s stocks to maintain control, and reserve the other 50% for investors and the employee option pool. It’s common for companies to set aside around 10-20% of the company ownership for employees.
- Select the Right Distribution Method – Choosing the right distribution method is essential to make sure every employee in your organization gets equal shares. That said, some company owners provide workers with equal shares while others use a reward system that gives most of the shares to employees who generate the highest revenue.
- Set a Vesting Schedule – Share vesting schedules are important, especially for those who prefer distributing it at once. That said, these schedules could also come in handy for employers who want to reward their staff on an annual, quarterly, or monthly basis. Some business owners even provide company shares as Christmas bonuses.
- Selling the Stocks at Discounts – Employers should consider selling company stocks at discounted prices. Of course, they will have to pay for their shares one way or the other, but you should still consider offering lower rates, preferably below market value.
Create an ESO Plan on Eqvista
Let’s say your company has 1,000,000 authorized shares, and you plan to offer 15% of the total amount of shares to your employees, ie. 150,000 shares in total. This ESO Plan would be on a 3 year vesting schedule with a 1 year cliff, and vesting quarterly thereafter, meaning employees working the company for less than 1 year would not be eligible to receive the company stock options.
This is how the overall vesting schedule would look on Eqvista:
Once your vesting schedule is set up on Eqvista, you can easily issue new options to employees and apply the vesting schedule to each option grant.
Let’s say an employee, John Lee, received a stock option grant of 5,000 options on March 5th, 2018. This is how the option grant would look like on Eqvista.
So according to the 3 year vesting schedule, John Lee has received 4,167 stock options already, and will have all 5,000 options by February 25th, 2021.
Transfer shares from one Employee to another on Eqvista
Another feature on Eqvista is the transfer of shares from one employee to another, let’s say in case an employee wishes to sell their shares to another staff member.
Let’s say after that John Lee also owns 1,000 common shares of the company and wishes to transfer to another employee, David Stone, for $3 each.
Here is how the transfer of shares would look on the Eqvista App:
And once the transfer of shares is complete, the share grant would show up in David Stone’s account as:
David Stone would also be able to access this information on his personal account in Eqvista, linked to his provided email account.
Transfer Shares to Your Employes on Eqvista
Transferring shares to employees may feel like an overwhelming thing, but when you really understand the process, you will learn that it is relatively straightforward and beneficial for company owners and employees. If you plan to issue employee stock options, consider talking to your business or tax attorney before doing so.
While some business owners choose this system for its various tax benefits, they must make sure they choose a plan that compliments their business model and a way to track all the information.
Eqvista is a complete cap table software for tracking and managing your company shares. Our platform has all the features around issuing and transferring shares to your employees, as well as sharing this information with them all online. Check out the features of our app or feel free to contact us today for a demo!