All posts tagged “startup company” startups

New Ideas for Social Impact

You are a bright, socially aware individual who sees that there are many things in society that need changing, but recognize that you need to also make a living. You also have a great idea to help people or you have the resources to help other people help people. Upon recognizing these needs, a lot of entrepreneurs have seen an opportunity to integrate a for-profit business model, while at the same time fulfilling a social need. This category of the market is called a “social business” or “social enterprise” and is a growing niche that needs venture capital and ongoing donor and investor support. That’s where Social Venture Partners Seattle (SVP) has stepped in.

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What Type of Equity Incentive Should I Use?

Startups and emerging companies frequently have to answer this question: What type of equity incentives should they use to incentivize service providers? For C corporations and S corporations there are generally 4 possibilities:


NQOs are stock options that are not ISOs under the Internal Revenue Code. Gain on exercise is ordinary income and subject to income and employment tax withholding.

ISOs are stock options that qualify for certain special tax benefits under section 422 of the Internal Revenue Code (no ordinary income tax on exercise—but watch out for AMT (alternative minimum tax)—and capital gain on sale if certain restrictions and 2 holding periods are met). Among other restrictions, ISOs:

  1. can only be granted to employees, pursuant to a shareholder approved plan;
  2. must have a term not greater than 10 years (or 5 in certain circumstances);
  3. must have an exercise price not less than fair market value as of the grant date (or greater in certain circumstances); and
  4. not more than $100,000 in value can vest in any 1 year.

By restricted stock, I mean actual stock issuances, subject to repurchase rights at cost (or similar restrictions), which restrictions lapse over a vesting period. By RSUs I mean units which entitle an award recipient to receive shares upon vesting.

And by phantom equity I mean a wide range of contractual arrangements (such as stock appreciation rights) that are not actual shares of stock, but are designed to approximate the rewards of stock ownership.


The type of equity award a company should grant its employees depends in part on the stage of the company.For very early stage companies the tax consequences of restricted stock can be favorable (employee starts capital gains holding period) and bearable (meaning the tax owed upon grant, if there are no repurchase restrictions, or in connection with filing an election under Section 83(b), if there are restrictions, is not too painful). However, once a company’s value has gone up, such that issuing stock from a tax standpoint is too expensive or too uncomfortable, I usually recommend companies use NQOs for the following reasons:

  • The potential benefits of ISOs (no tax on exercise (as opposed to ordinary income on the exercise of an NQO), and nothing but capital gain on sale) are rarely in fact realized.Usually the holding periods to obtain these benefits aren’t met, and the employee then has ordinary income when the stock is sold in a liquidity event;
  • The AMT consequences to an employee upon an ISO exercise are frequently more significant than expected (and being surprised that you owe more in tax than you expected is never good);
  • The company gets a tax deduction on the exercise of an NQO;
  • NQOs are less complex (you don’t have to worry about AMT adjustments, the consequences of not meeting holding period requirements, etc.);
  • NQOs are more transparent from a tax reporting perspective because you calculate and have to make estimated tax payments up front at exercise (which reduces the likelihood of a surprise at tax return filing time);
  • Restricted stock and RSUs are not as favorable as options because employees lose control over the timing of the incidence of the tax (if no Section 83(b) election is made at grant, restricted stock is taxable upon vesting (when the value may be significantly greater than at grant, meaning much more tax is owed than might have been initially expected), as opposed to an option which is taxable when the employee decides to exercise). Having some control over the timing of the incidence of the tax is important; and
  • Phantom stock or similar arrangements tend to be complicated and employees view them as inferior to actual stock options.

The table below summarizes some of the key federal income tax consequences of each of these types of awards. It is a high level summary only. If you want more detail, please contact me.

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Liquidity for Employees – Facebook’s Unique Solution

This week Facebook announced that an investor agreed to acquire up to $100 million of common stock from Facebook employees, which as I observed is a unique opportunity for private company employees.

Investors sometimes permit founders to achieve liquidity with respect to a portion of their equity holdings. This is typically accomplished either through the investor’s direct purchase from the founder of some of the founder’s common stock or by the company’s use of the funds invested by the investor to redeem a portion of the founder’s common stock. Facebook’s transaction is unique in that it extends this founder liquidity concept to employees, who typically have to wait for a company sale or public offering to achieve liquidity. Presumably Facebook’s board and management helped to negotiate this arrangement to reward long-time employees who have contributed to the company’s valuation growth over the past few years.

Such a transaction must comply with applicable securities laws and presumably includes an express acknowledgement by each selling employee that he or she realizes that the value of the shares being sold could rise and a release of all claims to any such future appreciation. While the Facebook transaction is very unique, given the state of the public markets such transactions may become more common.

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