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In startup world, what is preferred way to compensate employees: stock options or restricted stocks?

  • In startup world, what is preferred way to compensate employees: Stock options or restricted stocks?

  • Answer:

    For more senior executives, restricted stock tends to be the preferred method.  It positions the recipient for capital gains treatment upon a company sale, but it is subject to vesting to ensure that it is earned.  The major drawback, however, is that it has to be purchased at fair market value in order to avoid income recognition.  The greater the company's valuation, the more difficult that will become.  For more "rank and file" employees, the preferred method tends to be an option grant.  The option will typically be subject to vesting (either time or performance based) to ensure that it is earned, and it allows the holder to purchase the shares during a fixed period of time at a fixed price.  This essentially permits the option holder to wait for a liquidity event before exercising the option and putting his or her money at risk.  Also, at the time of grant, the option must have an exercise price of no less than fair market value in order to avoid some very nasty tax issues under Section 409A of the Internal Revenue Code and some similar state laws. One disadvantage of options is that upon exercise, regardless of if and when sold, the holder of a nonqualified stock option must recognize ordinary income based on the difference between exercise price and the then fair market value.  That could mean a tax liability to the holder without cash proceeds to pay the tax liability.  Although incentive stock options will not generate such phantom income upon exercise, they are subject to alternative minimum tax and if the conditions of the ISO are not satsified, they will be treated as a nonqualified stock option. Disclaimer.  All of my responses on Quora are subject to the Disclaimer set forth in my Quora Profile.

Bart Greenberg at Quora Visit the source

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The choice between Restricted Stock and Stock Options is dependent upon circumstances and facts. Only after a careful review of each should one be selected over the other. Some of the differences between both which can help employees make the right choice(s) can be enumerated in terms of: 1. Valuation 2. Taxation and 3. 409A Valuation Valuation Restricted Stock vs Stock Options Restricted Stock always has some value at vesting even when the stock price falls below grant date price.E.g.  Company grants an employee 2,000 shares of restricted stock when the fair value is $20. Considering a vesting schedule of 1 year cliff and fair value of $10/share on vesting date, the restricted stock is still worth $20,000 (2,000 shares * $10/share) to the employee. Instead, if company granted 2,000 ‘stock options’ with an exercise price of $20 and at vesting date the fair value is $10/share, there is no real value and the options are considered ‘underwater’ or worthless. For further details regarding Differences in Taxation and 409A Valuation of Restricted Stock vs. Stock Options Visit:http://tmblr.co/ZW8wLsljPqot

Arushi Bhandari

As Arushi noted, it depends on your circumstances. There are pros and cons for each type of instrument. Stock options give you the right to buy shares at a certain price after a vesting period. This typically occurs after your one-year anniversary date, with 25% transferred to you each year over a four-year period. The key here is that you must purchase the options. The idea and hope is that by the time you’re eligible to buy the options, the stock has appreciated. However, stock value could erode making it worthless, which doesn’t happen with restricted stock units (RSUs).RSUs are similar to options in that there’s a vesting period where the employee must satisfy certain conditions before the stock or its value is transferred. Such conditions are usually tied to a period of time or based on work performance. Unlike stock options, there’s no purchase involved. Instead, a certain number of units are granted to the employee, but there’s no value until after the employee has met the vesting requirements. After vesting, the employee may transfer the RSUs. Thus, RSUs always retain a value, in contrast to options that can decline in value by the time of vesting. The value of RSUs is the closing market value of the stock price on the vesting date. That’s also the point at which your tax liability is triggered, requiring you to pay withholding and income tax on the amount received.As always, please understand this answer is not offered as advice, but only to provide general information. There is no substitute for getting sound advice from a professional. Since there are many considerations involved with the complexities of these transactions, you really need to have personalized advice specific to your circumstances. Please check out https://www.lawtrades.com/?t=quora in order to connect with an experienced startup attorney for additional guidance about evaluating RSUs and stock options.

Raad Ahmed

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