Equity-based compensation packages are often used to incentivize and retain an executive team or key employees. These non-cash compensation programs allow companies to provide additional compensation without increasing salaries. For the employee, these programs allow them to benefit from the future growth of their company, along with the appreciation in its market value.
While most investors are familiar with such programs being offered by large, publically traded companies, private or family-owned companies can structure a non-cash compensation program as well. For the company, the first decision is whether the owners are willing to dilute ownership by transferring ownership rights to employees.
If a private company wants to maintain their current ownership structure, or perhaps they cannot offer ownership plans because of the company’s structure, business owners may consider using either phantom stock or stock appreciation rights (SARs). Phantom stock is essentially a bonus that is tied to the value of company shares. The bonus is usually paid in cash after a vesting schedule, often at predetermined dates. As the company grows, employees are rewarded with the bonus, which is taxable as ordinary income when received. Because the bonus is tied to the stock value, a private company will often have annual business valuations to determine the equivalent stock price. SARs programs provide a great deal of flexibility for the company. For the employee, they work similar to phantom stock, except the bonus is the equivalent to the difference between the value of the stock when the shares are granted and the value of the stock when the SARs are exercised.
If a company is willing to dilute company ownership, they may offer stock options, restricted stock, employee stock ownership plans or employee stock purchase plans. Most of these programs come with voting rights. Private companies may include rights to buy back the shares to maintain majority ownership.
Stock options allow employees the option to purchase shares of the company at a specified price over a set period of time. However, if the company’s stock decreases in value, the options may be worthless, which may be why many companies prefer to offer restricted stock. Restricted stock always has a monetary value. Shares are transferred to employees at little or no cost. The employee’s restricted shares are worth their fair market value the day they are fully vested. The employee then has the right to hold or sell the shares.
If a company is truly interested in transferring ownership to the employees over time, qualified plans, such as employee stock ownership plans (ESOP) or employee stock purchase plans may be used.
With an ESOP, the company is generally required to establish a trust where the company contributes shares or cash on behalf of the participating employees. Like most stock plans, the shares are transferred to the employees over a period of years. Once the employee receives the shares after retirement or termination of employment, the employee can choose to either hold or sell the stock.
Employee stock purchase plans generally allow employees to purchase a specific amount of stock at a discount to the fair market value through an after-tax salary deduction. However, with an employee stock purchase plan, the employee is generally able to sell shares when they like.
While these plans may be an attractive offer, employees may fall victim to the belief that because it is a great company to work for that it is a great stock to own. Long-term employees may find themselves in a situation where they have too much of their investment portfolio invested in one stock. The employee, who invests in their own company, may be relying too much on one company for both their income and their retirement funds.
Overall, non-cash compensation plans provide a lot of flexibility for both the company and the employee. They can be structured in any number of ways, depending on whether the owners want to maintain full ownership of the company or transfer some ownership rights to the employees. If you have questions regarding how non-cash compensation plans may work for your company, or if you participate in a company stock plan and want to know how your options fit in your overall financial plan, the experts at Henssler Financial will be glad to help:
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- Email: experts@henssler.com
- Phone: 770-429-9166.
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