Wednesday, May 19, 2010

Too small to cope with 409A regulations? Try Restricted Stock!

One of the things about 409A regulations is that it imposes a valuation requirement on you, which could be expensive depending on the service provider. Not every service provider operates efficiently and only a few like us are able to provide the highest quality at affordable rates. It took a lot of trial and error work, technology utilization and template work to get to this business proposition. If you are a very small founder and your head swims over how to create paperwork for 409A compliance, I recommend you use restricted stock for your employees. Restricted stock is outside 409A requirements and you dont have to get a valuation done to determine the fair market value of the underlying stock at the time of the grant. While restricted stock units are attractive, if you include clauses such as the right to call back the stock, then the position maybe treated akin to an option and may end up falling under 409A. So, make sure you issue a plain vanilla restricted stock. You also attract taxes only when you actually book a capital gain on the stock rather than a possible tax payment right at the time of grant as in an option. There are advantages to issuing an option such as the inexpensive costs that companies have to bear and significant upside, should the stock price go up. But if the stock price went down, you may not have any stock at all, unlike in a restricted stock scenario where your stock is worth something unless it goes to zero. This means that it is important to issue stock options at very early stages of a company's development but the hitch is that it requires significantly more paperwork than restricted stock. Hybrid solutions are possible. Please contact us to learn more.

1 comment:

David said...

The tax consequences of restricted stock are that it is taxable on its fair market value when it is no longer subject to a substantial risk of forfeiture. This is generally when the restricted stock vests. If you grant low value restricted stock to an employee, he or she can make an 83(b) election and take the income tax hit up front and then only pay capital gains tax when the stock is sold, but if you have restricted stock and an no 83(b) election, there could be unexpected taxes as it vests. Great information about 83(b) elections here.

This is a complicated area and you should get advice from someone experience before you do anything.