Equity grants can be an attractive alternative to cash when compensating employees, consultants, and service providers. Beware, though: if not structured properly, equity grants can cause some nasty consequences for the company and the recipient, including issues related to taxes and labor and employment laws. Deciding on the proper number of shares can also be difficult. Difficulties aside, though, equity grants are among the best ways for you to attract superstars for your company.
Let’s start with the fact that an issuance of stock can result in a tax liability for the recipient, as if he or she received cash. Considering that the equity of most private companies can’t be readily sold (it is “illiquid stock”), the result is a tax bill for the recipient with no cash to cover the taxes. There’s no guarantee that the shares will ever result in cash proceeds.
In many cases, a stock option, with a strike price equal to the fair market value of the underlying shares on the date of grant, will be the preferred form of grant. These options also would normally be subject to vesting. You can think through a few of the various choices for structure in stock options here.
What’s the correct number of shares to issue? As for the right number of shares, everyone knows that the real question is one of percentages, not numbers. Many companies prefer a cap table that allows them to issue grants for at least 10,000 shares. Think about the optics of it: Larger numbers look and feel better, even though the recipient knows that a large number may represent a small percentage.
Last, what’s the right percentage of the company to grant? When considering the right percentage for a grant, the two most common reference points are: 1) what have other individuals in the company received, and 2) what do similarly situated recipients in comparable companies receive? Legal advisors can also provide a certain sense of market terms for different roles, ranging from low-level employees to the C-suite.