Here is a quick list a company can refer to prior to issuing stock options to its employees. I’ve covered the basics of stock options in a previous post, as well as a more in depth pricing item related to stock options, but wanted this post to give the broad overview to founders.
If your company operates in New York and meets the definition of a “qualified emerging technology company” (a “QETC”) it is eligible for New York tax credits. Additionally if you are a New York State taxpayer and interested in investing in a QETC you may be eligible to claim a credit as well.
In addition to the other ways we’ve discussed here (stock options, phantom stock, stock appreciation rights), another way to compensate individuals working for a startup is to give them a cash payment upon a change in control of the company, called in the industry a “strip right”.
For example if a startup company has four founders each owning 25% of the shares, and they bring on another but don’t grant him or her shares, the initial founders can agree to pay the new individual a percentage of the “net proceeds” received from a “change in control” of the corporation. “Net proceeds” is usually defined as the gross proceeds received minus transaction costs and brokers commissions as well as some other items. A “change in control” is defined as it normally is in these agreements, and covers if the company merges with another or sells substantially all of the company’s assets. In such a case, the shareholders would receive cash (or assets it can sell for cash, like tradeable shares of the acquirer). The strip right agreement would require the shareholders that granted it to pay to the holder of the strip right, either a percentage or flat fee before they received their cash for the change of control.
In the example, if the four founders grant a 10% strip right, and a couple years down the road the company is sold for one million dollars, with transaction fees of $100,000, the holder of the strip right would receive $90,000 (net proceeds of $900,000 x ten percent). The shareholders would split the rest of the $810,000 and each receive $202,500.
One of the benefits of the granting of the strip right is that it is not taxable to the recipient. The downside, at least to the recipient is that they are not a shareholder of the corporation and they may never receive a cent if there is never a change in control. Due to its tenuous nature, the strip right is usually granted in connection with other compensation awards.
Starting at the beginning of 2014, New York’s STARTUP-NY Program went live. Here is the official website for the initiative. Its goals are laudable but its only available to a small niche of companies. If your company qualifies, however, the benefits are rather nice.
In summary, the Program provides eligible companies with free office space (at certain locations) for a period of time and the employees of the company pay no state income tax on their income (at least for the first five years, with a small amount possibly paid in years 5 through ten). The Program is attempting to lure out-of-state companies into New York, while encouraging sprouting of new startups that otherwise may not have started without these benefits. Overall New York is looking to add more jobs in the state, and the more jobs now (even with tax breaks) the more taxes the state can collect in teh future.
As I’ve written about in the past, founders of a startup should have their equity vested. There are times when you may not want to, but the majority of the time it is beneficial. Some investors may insist upon it, although its one of the things in the negotiations. If the founder’s stock is vested, they should make an 83-b election. To not do so could turn into a lot of tax due to the IRS over the years the stock will vest. We’ll discuss how it works and how to make the election here.
This is a very important topic to ensure that your startup continues to be controlled by founders dedicated to its cause. What you want to avoid is a situation where a group of founders form a startup and each hold a similar percentage of the issued shares – without any restrictions on such shares. If only one or two of the original founders continue working for the corporation, and the rest stop, and either get other full-time jobs, move away, leave the country, etc., then the founders that are still around can be stuck and essentially handcuffed from making certain corporate decisions. If the corporation, as most due, requires the majority of the issued shares to take certain actions, and the corporation brings in other people from the outside as shareholders and/or directors (usually investors), then the founders who have stuck around will have essentially less of a say in major corporate actions. And if there is a liquidation event, then the founders who have left will get paid without having to put in the hard work.