In the first part of this blog series, we discussed the ins and outs of transferring stock ownership to family members. This blog, part two, will focus on transferring stock ownership to non-family employees and unrelated third parties, as well as the advantages and disadvantages of employee stock ownership plans.

WHY TRANSFER OWNERSHIP?

Why do people transfer ownership of their company stock? It could be due to a transition of management; a tactic to attract, motivate, and retain key employees; or for liquidity purposes. Whatever the reason, if you are considering transferring stock to an employee, make sure you understand your options to secure an approach that works best for you.

STOCK GRANTS OR STOCK PURCHASES

It is imperative you know the value of your business before considering an approach to transferring stock. Transfers to non-family employees can be made through stock grants and purchases. Stock grants are made when a company compensates an employee, fully or partially, in the form of corporate stock. They are taxable to the employee and are deducted by the company. Stock purchases allow employees to buy shares of the company. They are taxable to the seller. It is common to have vesting periods in the range of 3-5 years for stock grants and purchases.

STOCK OPTIONS

Stock options provide an employee the right to buy a certain number of shares in the company at a fixed price for a certain number of years. The price at which the option is provided is called the "grant" or “strike” price and is usually the market price at the time the options are granted. There are two types of stock options – nonqualified stock options (NSO) and incentive stock options (ISO). NSOs are more common; when the employee exercises the stock option, they have ordinary income reported as wages equal to the difference between the strike price and the fair market value at the time of exercise, and the Company receives a corresponding tax deduction for compensation. ISOs are less common and more restrictive, but in contrast to the NSOs, the employee generally is not taxed upon exercise, and the Company does not receive a tax deduction.

PHANTOM STOCK AND STOCK APPRECIATION RIGHTS

Phantom stock and stock appreciation rights (SARS) are cash-deferred bonus plans based on the value of the company’s stock. SARS are based on an increase in value, while Phantoms are based on the value of shares. These plans create less risk for employees because there is no purchase required. However, they have ordinary income instead of capital gains. Usually, these plans are paid in cash but can also be paid out in stock.

EMPLOYEE STOCK PURCHASE PLANS (ESPP)     

Employee stock purchase plans (ESPP) are not very common in small businesses. They allow employees to purchase company stock at a discount of up to 15% discount (no more than $25,000 annually).

EMPLOYEE STOCK OWNERSHIP PLANS (ESOP)   

An employee stock ownership plan (ESOP) is a tax-exempt retirement plan that borrows money from a bank/shareholder to purchase stock from another shareholder. A 401k plan is often merged with an ESOP to provide the equity needed in order to borrow. Advantages: If the company is a C Corporation, and the shareholder sells more than 30% of the total stock, the proceeds can be reinvested and tax-deferred. A C Corp can convert into an S Corp after the sale, where the ESOP can own either all or a portion of the corporation. Loan payments associated with this plan are tax deductible. At retirement, ESOP participants can roll their benefits over to a self-directed IRA. Disadvantages: A disadvantage associated with ESOPs is that they require additional costs and compliance for audit and valuation. ESOP valuation for a selling shareholder may be less than for a strategic buyer. In addition, ESOP participants generally cannot receive capital gains treatment upon sale/retirement.

SALE TO UNRELATED THIRD PARTIES

• Private sale
• Private equity
• Partial vs. complete sale