There are two primary ways to grant an equity incentive to an employee. First, you can issue the stock outright (meaning the recipient is purchasing and receiving their stock shares at the time of issuance). Or, you can grant the employee a stock option (meaning the recipient does not receive their stock shares until they exercise the stock option at a later date).
A few things to consider when thinking about issuing stock shares directly to an employee:
- Receiving shares outright will require the recipient to either purchase those shares, or to recognize taxable gain on the value of those shares. This is not a problem when the company is a fresh startup with no innate value. However, once a company has innate value, this may be a less desirable outcome for the recipient.
- Receiving shares with vesting will require filing an 83(b) election.
- Receiving shares outright leads to the recipient holding immediate voting power.
- Recipient gets to start long-term capital gains and QSBS holding periods immediately if they receive the stock at time of issuance.
And here are a few things to consider when looking at issuing stock options to an employee:
- Receiving an option grant means that the recipient does not need to pay out of pocket to purchase shares until they either leave the company or the company has an exit. This is usually a better option for a standard employee.
- Receiving an option grant (even with vesting) will not trigger an 83(b) election requirement.
- An option recipient does not hold any voting rights until the option is exercised.
- Capital gains and QSBS holding periods won't start with an option grant until it is exercised.
- Non-statutory stock options (NSOs) may need to pay taxes at the time the option is exercised based on the increased value of the underlying shares. Incentive Stock Options (ISOs) typically will not.
A common situation for startups is that they choose to issue stock outright to the founders and earliest employees, since the stock will not have any underlying value early on, but then when they hit their first financing event (or something else that causes the company to have a significant valuation, like increasing revenues), they transition to issuing employees stock options (so the employees don't have to pay anything for their equity grants).
Regardless of whether the company is granting stock options or issuing shares outright, Savvi has automated workflows to get the necessary board consents and equity agreements in place for those equity incentive grants.
Savvi Technologies, Inc. is not an attorney or a law firm, and can only provide self-help services at your specific direction. Do not rely on any documents or information from Savvi without consulting an attorney. Savvi may partner with or refer clients to licensed attorneys, but such referral does not constitute an attorney-client relationship until the attorney is officially engaged by the client.