Key Employee Ownership

If you are thinking about giving equity, or actual company ownership, to one or more key employees, you should first congratulate yourself. You recognize that surrounding yourself and your business with quality folks aligned with your mission is the best way to assure the company’s success.

When exploring equity options for your employees, there are many things to consider. Each approach comes with its own pros and cons and decisions related to financial matters, long-term options, taxes, and buy-sell agreements.

Financial Matters

If you require your employee to buy the equity, you must first decide what the price is.

You might consider whether there should be a price “discount” since they will have a minority and non-marketable interest and therefore will not have voting control. 

After settling the price, your employee will need to pay that price, either up front or over time. Because many employees will not be capable of paying the full amount right away, you can also give them the equity as a bonus. 

Doing this saves them the burden of trying to come up with the money right away while still allowing them to receive the financial benefit of ownership. This might motivate them to work even harder to contribute to the company’s success.

Taxes and Long-Term Options

If you give them equity as a bonus, the key employee will need to pay income and FICA

taxes as if they are getting that much in cash, even though they are really getting a piece of paper confirming their ownership of the company. While your employee might not be thrilled about paying these taxes, they can take comfort in knowing that they are now paying much less than the full purchasing price.

There are also other considerations to be made. Because you as a business owner are showing a major step of trust, you may want to be assured that your employee will stay with the company on a long-term basis. In order to accomplish this, the equity can be given subject to a vesting schedule. This means that the employee actually owns the equity at the outset but may lose it if they leave the company before the respective vesting date. 

Under federal tax law, your employee may be able to pay the taxes at the outset on the entire amount and at today’s value, even though they may lose it if they leave early. Alternatively, they may wait to pay taxes as they vest, but then the tax is determined based on the value at the time of vesting.

Another way to ensure that the employee stays with the company long-term is to give

them the right to get equity over time. In that case, they will own the equity down the road, and they pay the taxes based on the value at the time they received the equity.

Buy-Sell Agreements

Finally, you will want the key employee to sign a buy-sell agreement that deals with their ownership if they ever leave the company. Often, these agreements provide that your company will buy their equity back, with the payment to be made over time.

As with most things in business, settling ownership matters can take time, but there are many benefits to having key employees own equity in your business, even if it is in a minority position. For more information on business law, reach out to our team at MKP Law today.