Some employee benefits may be relatively easy to understand. A 401(k) for example, with a company match, is a benefit that many employees are familiar with. Other benefits are more complex. Private company equity compensation, for many, falls into this category. The benefits and limitations of private company equity compensation usually require close examination or even professional guidance.
When a private company grants equity to its employees, independent contractors, directors and others, the most common awards are interest in the partnership or LLC (e.g., a profits interest), restricted stock (RS)/restricted stock units (RSU), and stock options (both non-qualified and incentive). These types of awards, while similar to the awards at public companies, have unique complexity which is important to understand. Just as one example, certain types of equity compensation offer employees an equity award where they are required to stay with the company for a certain amount of time before earning full ownership of the equity. Read the full report here.
How are private company equity grants different?
One of the biggest differences between a private company’s equity and public company’s equity is liquidity. Private company equity holders may have very limited liquidity. Public company equity, by contrast, has more liquidity than private company equity as public stocks are traded daily through public market exchanges.
Key takeaways
From Goldman Sachs Insights, here are some important planning opportunities and considerations to weigh when evaluating private company equity compensation:
- Lack of Liquidity. As private company stock is not listed on a stock exchange and resales are restricted by both the U.S. Securities and Exchange Commission (the SEC) and the company specific rules, it generally has little or no liquidity.
- Greater use of Stock Options and Profits Interests. In comparison to public companies, private companies —especially in their early years—tend to issue stock options (commonly ISOs and/or “early exercise” options) and profits interests over other types of equity.
- Valuation. They require a valuation, which may include independent third-party appraisals.
- Vesting Conditions. Vesting typically occurs more frequently than vesting of public company grants.
- Double Trigger Vesting. Restricted stock and RSUs are often subject to double-trigger vesting, which means there are two conditions that must be met for vesting—typically a specific time frame and the occurrence of an event.
- Company Rights. Private companies often retain certain rights upon the grant of equity. These rights may include a right of first refusal, a stock buyback, and/or repurchase rights.
- Preferred Shareholder Rights: Upon the sale of the private company, preferred shareholders would have the right to any proceeds before others.
Tax Complexities
If you receive private company equity as payment for your services, you may have income when you receive the equity, when you exercise an option, and/or when you dispose of the equity received. Consulting a tax and/or a financial advisor may help you determine your best course of action when receiving private company equity.
Timing is important
The general rule is that once a service provider’s compensation is no longer subject to a SRF (Substantial Risk Forfeiture), it will be subject to taxation. There are certain situations, however, where this general rule does not apply and the timing of taxation differs. For example, if a service provider makes a timely §83(b) election on a property interest (subject to SRF) at grant or if an equity grant is deferred after the SRF has been met.
Again, a tax and/or financial advisor can help to guide you through the tax complexities, including when to exercise your options and the consequences. The rules are complicated. But it’s important to remember that this is a part of your employee compensation package and making certain that you can maximize the benefits is important in order to help you to reach your financial goals.
