Employment Matters & Equity Compensation
Documenting employment and independent contractor relationships is essential. Litigation commonly arises from a variety of avoidable circumstances in addition to the countless regulatory and tax pitfalls. Carefully delineating these relationships with written agreements is your first line of defense.
The reasons for considering issuing equity compensation range from preserving company cash flow/reserves and motivating employees by providing them an equity stake in the performance of the company as a whole. Increasingly, however, employees are looking for equity compensation packages as a feature of the overall employment marketplace and frequently compare notes on offers with friends and colleagues.
You may wish to consider using the following:
(a) Employment Agreement. Long-form agreements are appropriate for your company’s CEO and other key executive officers. Shorter agreements may be appropriate your other employees, such as those employees who may be terminated “at will,” as opposed to executives who typically serve the company for defined periods of time (or terms) and may only be terminated for defined reasons (or cause).
(b) Consulting Agreement/Work-For-Hire Agreement. This agreement is designed to be used for each of your company’s consultants, including both individuals and entities providing services to the company as independent contractors instead of employees. The distinction between independent contractors and employees is complex, requires careful analysis, and has important tax implications.
(c) Stock Option Plan. As suggested above, many companies use employee stock options to compensate, retain, and attract employees. The Stock Plan is the general governing document containing the standard terms and conditions of the options to be granted. It also specifies how a given option plan qualifies for tax preferred treatment, if at all.
(d) Option Agreement. Stock option agreements specify the individual options grants, vesting schedules, and other employee-specific information. Each grant of options will be documented by a separate option agreement.
(e) Restricted Stock Purchase Agreement. These are to be used when equity grants under the Stock Plan are made as restricted stock awards rather than options. They include specifics regarding the repurchase right of the company and how it will lapse over time. These are not as common as options.
(f) 83(b) Election Form. Many founders, executives, and employees receiving options wish to make an 83(b) election in order to preserve possible future taxation benefits. A Section 83(b) election is an election to include in income the value of property that is subject to a substantial risk of forfeiture, such as a company repurchase right in the purchase agreement, which repurchase right lapses over time as a founder provides services to the company. Because the stock is subject to a substantial risk of forfeiture, the employee does not have to pay tax on his receipt of the stock until it vests. Often an employee may make a Section 83(b) election to pay tax on the value of the stock today because its value is lower than it is expected to be when the repurchase right lapses, or because the employee paid full value for it at the time of purchase so the Section 83(b) election incurs no additional current tax. The making of the Section 83(b) election also starts the employee’s capital gains holding period.
(g) 25102(o) Notice. Companies issuing stock options must comply with state and federal securities laws. Non-compliance can lead to lawsuits by investors and civil or even criminal prosecution by government agencies. Frequently the stock option grants are structured to fit within exemptions to the laws that generally require registration of the securities. A common exemption for Stock Plans for option issuances in California is found in Section 25101(o) of the California Corporations Code.