Equity Inventive Awards 101
The purpose of equity incentive awards is to encourage and enable the officers, employees, directors, and consultants to acquire a proprietary interest in the Company. Providing such persons with a direct stake in the Company will assure a closer identification of their interests with those of the Company and its stockholders, thereby stimulating their efforts on the Company’s behalf and strengthening their desire to remain with the Company.
For startups, the vesting schedule which the Equity Incentive Awards subject to is usually the key component to maintain a stable core founders team.
Types of Equity Incentive Awards include:
Restricted Stocks—usually to founders
Incentive Stock Options (ISOs)—to employees only
Non-qualified Stock Options (NSOs)—to employees, directors, and advisors
Restricted Stock Units (RSUs)—rarely used by startups
Stock Appreciation Rights (SARs)—less common for startups
Phantom Stocks—less common for startups
Issues to consider when deciding which type of Incentive Awards to issue include:
The identity of the grantee (founder, employee, director, or advisors)
Internal Revenue Code (IRC) sections to Pay Attention to:
Section 83(b) election
The 83(b) election gives an employee, or startup founder, the option to pay taxes on the total fair market value of restricted stock at the time of granting. Not available for RSUs and Phantom Stocks.
Section 409A regulates nonqualified deferred compensation paid by a "service recipient" to a "service provider" by generally imposing a 20% excise tax when certain design or operational rules contained in the section are violated. Should take this section into careful consideration, especially if to issue NSOs, RSUs, SARs, and Phantom Stocks.
To issue Incentive Awards, 3 documents generally need to be drafted:
an Incentive Award Plan, which is the governing document containing the terms and conditions of the equity awards to be granted;
an Award Agreement (between the Company and each grantee). This Agreement specifies the individual awards granted, the vesting schedule and other grantee-specific information; and
a Notice of Award Grant (given to the grantee, usually attached to the Award Agreement). It is a short summary of the material terms of the grant.
In addition, the Board of Directors and the stockholders must approve the adoption of the Incentive Award Plan; and the Board or a committee thereof must also approve each individual grant of awards, including a determination of the fair market of the underlying stock.
** This blog provides general information for educational purposes only. It is not intended to constitute specific legal advice and does not create an attorney-client relationship.