Restricted Stock vs. Stock Options: Deciding How to Compensate Your Employees

Issuing equity in a company is a popular form of employee compensation. This trend is especially popular here in Silicon Valley, where startup companies often defer cash compensation to their employees in exchange for a share of future growth through the issuance of equity. If you own a non-public company, you may wish to compensate your employees partially by issuing them equity in the company. Equity aligns incentives between employers and employees while enabling employees to build up wealth over a longer term. Equity issuance can be done in different ways, including by issuing restricted stock grants or by issuing stock options. Each of these forms of compensation can have its own pros and cons and you want to make sure you carefully analyze the decision and decide which is best for your circumstances.

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Restricted Stock

Restricted stock is a stock award that will not fully transfer to the employee until certain conditions have been met. These conditions can include a certain length of time working for your company, meeting certain performance or financial goals or milestones, and more. These restrictions can be helpful for owners to ensure that employees do not simply walk away from your venture and that they must wait for the award to vest before they receive the stock benefits. In addition, by making an 83(b) election with the IRS within a certain period of time after the restricted stock grant, employees can save significantly on the tax burden once the stock vests. If no election is made, however, employees may face hefty tax liability at the time of vesting depending on the value of the shares. Restricted stock is less risky and easier to manage in comparison to regular stock.  However, restricted stock has less favorable tax treatment than options.

Stock Options

Stock options are the most common and well-known form of equity compensation among startup companies. The options give employees the right to purchase a specific number of shares in the future at a pre-set price (known as the exercise or strike price) for a designated period of time.  However, if the strike price is set too low and the employee waits until the next year to exercise their options, the employee may face significant tax liability. This is because the IRS will tax the stock based on the difference between the strike price and the true value of the stock. To avoid such taxes, you must set the strike price at a point that reflects the value of your company. This can require having a professional (but potentially expensive) appraisal conducted. The two major types of options are incentive stop options (known as ISOs) and non-qualified stock options (known as NSOs). ISOs can only be granted to employees, but NSOs can be granted to anyone. ISOs have more favorable tax treatment in comparison to NSOs.

An Experienced San Jose Corporate Business Attorney Can Assist You

If you are an owner of a non-public company and are trying to decide between issuing equity compensation to your employees in the form of restricted stock or stock options, you should carefully weigh each option with the help of an experienced silicon valley business attorney who understands California tax and securities laws. At Structure Law Group, our attorneys can evaluate your situation and help you make the decision that is best for your corporate success and for your employees. Please call us at 408-441-7500 for help today.

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