Equity Incentive Plans: Compensating Key Employees with Equity, Options and Equity Appreciation Awards



There comes a point in the life cycle of many businesses when its employees desire equity in consideration of their services to the business—the employees want to become owners and not just work for the business and its owners. Wanting to align the interests of the employees with those of the business, the business owners may be receptive. What the business owners do not want, however, is to give upcontrol of the business or adopt a system that is burdened with legal and tax complexities.

This article will discuss the factors that businesses, particularly those that are closely held, should consider when developing an equity incentive plan while giving a basic explanation of the key legal and tax concepts involved.


Characteristics of Equity, Options and Equity Appreciation Awards

The first issue that business owners should consider is whether they are willing to provide the employee with (i) a present equity interest in the company, (ii) an option to acquire an equity interest in the company at a future date, or (iii) an equity appreciation award, consisting of a contractual right to receive a future payment in the event the company subsequently appreciates in value, but otherwise provides no equity holder rights.

Equity ownership of a company gives the equity holder certain legal rights. While such rights differ by state, they typically include the right to inspect the corporate records and possibly the right to receive the financial statements of the company. Equity holders also have the right to vote on so-called fundamental transactions, such as mergers, acquisitions, a sale of the company and the right to approve an amendment to its articles of incorporation or bylaws.

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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