It takes a lot of effort to attract talented individuals to join your team. To help ease the process it’s important to start by evaluating what you offer compared to your competitors. Presenting an attractive opportunity is as much about the value package you provide as it is about the work and culture.
To help you think through some of these factors we’ve broken this post into two parts. Alex King of Bend Law Group will discuss equity compensation, and Mark Lutton of TriNet will bring it home with a brief discussion about Medical Benefits and the importance of implementing the right “strategy” for your company.
Incentivizing Employees with Equity Compensation
By Alex King, Bend Law Group, PC
When you’re a startup, it’s important not to overlook the equity compensation aspect when filing the certificate of incorporation. Most businesses don’t grant stock options or seek venture capital as their options continue to grow and expand. However, because a startup will seek to scale and grow, we strongly encourage our clients to authorize 10,000,000 shares when they file the certificate of incorporation.
Now you may be saying, “but couldn’t we obtain the same results just sticking with 1,000?” Yes, you could! But unfortunately people (employees/consultants/directors) like to have a large number of stock even if the percentage of the company would be the same. 50,000 stock options sounds better than 5 even if they mean the same ownership percentage of the company, and we cannot discount ego and vanity when people are comparing an offer within their networks. Thus, a key aspect of the long-term planning involves compensating future service provisions through equity compensation.
When planning for the future you must also keep in mind that you cannot sell or give away stock unless the securities are either (i) registered with the SEC, or (ii) are issued pursuant to an exemption. Rule 701 is the federal securities law exemption for compensatory equity issuances.
When creating an equity compensation strategy, here are a few key components to consider:
1. Disclosure Requirements
Rule 701 requires issuers to provide the service provider with a copy of the equity incentive plan.
2. Understand How the Number of Shares Impacts Future Investment
Keep in mind when deciding how many shares to contribute to the plan that investors will calculate the share price on a fully diluted basis. For example, if the founders owned 6 million shares, and the equity incentive plan had 2 million, the investors would say the fully diluted the share structure was 8m, and not 6m, even if no one had received shares out of the equity incentive plan at the date of investment. Therefore, it’s very important to put only the amount of shares you forecast you’ll need to attract the talent necessary to fulfill key roles.
3. What type of Grant Makes Sense for the Company
An equity incentive plan that authorizes multiple types of awards will permit greater downstream flexibility, even if the company only intends one type of grant at the time of creation.
Here’s a quick breakdown of the two primary awards:
i. Stock Options
A stock option gives the holder the right to purchase shares at a fixed exercise price over a specified period of time. The award may either be an incentive stock option (often referred to as an “ISO”), which can only be granted to employees, or a nonqualified stock option, which is commonly used with consultants and advisors.
ii. Restricted Stock
Restricted stock is a grant of equity that remains subject to forfeiture until an applicable vesting schedule lapses.
The key difference is that a grant of restricted stock is immediately taxable (unless the service provider pays for the shares) and the service provider may vote and receive distributions on the shares even though they may be subject to vesting.
Furthermore, stock options may or may not be deferred compensation subject to Section 409A of the Internal Revenue Code. The analysis depends heavily on if the option was granted at or above fair market value, and the consequences for failing to comply with 409A are severe. Of Internal Revenue Code Section 409A’s three approved valuations, the two that are most pertinent are (1) independent appraisal, which is done by a professional firm experienced in valuation methods, or (2) a company that has been in existence less than 10 years and does not reasonably anticipate an IPO (or acquisition) in the next 180 days can rely on a valuation performed using Section 409A’s enumerated valuation factors by a person (can be a company employee) with significant knowledge and experience or training performing similar valuations.
What this brief discussion highlights is the importance of following both the SEC and IRS rules for equity compensation. Crafting a proper plan so that you are capable of granting proper equity compensation that competes or exceeds your competitors can be one of the key factors for why a candidate chooses you.
Medical Benefits
By Mark Lutton, HR and Medical Benefits Consultant
As Alex stated, it absolutely takes a lot of effort to attract talented individuals here in the Bay Area and even more to retain them. So how do Medical Benefits play a role in this?
I would submit to any company the answer is all in your company’s “strategy” behind your Medical Benefits offering.
I meet with start-ups on a weekly basis in an effort to help them navigate through all the complexities of having “a” employee, let alone 5 to 100 employees here in the wonderful Bay Area. A question I always start my meetings with when it comes to benefits is this:
“Do you offer medical benefits?”… Sounds like a crazy question to most because what qualified and talented candidate is going to accept an offer from a company that doesn’t offer benefits, right?
So why do I ask this question?
I ask this question because 95% of the time the answer is “yes, of course we offer medical benefits.” That then leads me into my follow-up question, which will always be…. “Why do you offer medical benefits?”
A company’s response to this very basic question and the subsequent discussion it leads to will give me more insight on how I can help them than almost any other discussion we will have.
Allow me to explain.
The 5%:
If I am meeting with the owner(s) of one of these companies and they tell me “We don’t offer medical benefits because we don’t care” (and trust me this happens) I typically will end the meeting because at the end of the day if you don’t care about your employees, then I don’t want to do business with you and I can’t “help” a company at that point. Furthermore, I feel bad for your employees. I digress…
The 95%:
Over the years I have heard a multitude of responses as to why a company offers Medical Benefits. From “because we legally have to offer them” to “my employees are my most valuable part of my business so I take care of them” and everything in between.
But what is right reason for offering Medical Benefits?
In my opinion it is important to understand the “right” reason for offering medical benefits will be unique to each company. However, the “strategy” behind the Medical Benefit Offering is where the focus needs to be.
As a start-up it is imperative that you understand that the power lies in the implementation of your “strategy.” When my team and I work with companies we have to always look at the dynamics of the company. We evaluate the demographics (is it primarily millennials, baby boomers, a blend, etc.), we look at the culture and how it plays into the business as a whole, and from there we begin building and then implementing the “strategy.”
For anyone who has ever had to look or “shop” all the different medical carriers here in California and all the different types of plans and offerings each carrier has, it is overwhelming to say the least. There are literally thousands of plans and a plethora of providers.
That being said, when putting together your “strategy” you will have to understand the following in great detail:
1. The Company Contribution:
First figure out your company’s contribution strategy. How much of the premium are you going to pay? 100% of the premium for the employee and their family? 100% for the employee and 50% for their family? 50% for the employee and nothing for their family? Something I believe is crucial for any company venturing to do this without outside help is KNOW WHAT YOUR COMPETITION IS OFFERING. That piece of information will be your building block for your “strategy.”
Why is that?
Because it is important to understand that just because your competition offers 85% or 100% medical benefits contribution that doesn’t mean the plans they offer make any sense to the talent they are seeking. Your competition could be throwing money out the window because they have a flawed strategy!
For instance, the millennial candidate you may be seeking does not need nor want to pay anything for what a 30-year-old to 50-year-old with a family will require. So paying for that premium for your millennial hire with a 100% contribution from you is bleeding your capital for no reason.
A high deductible plan that costs very little to the company and nothing to the employee per month means a lot to a young professional who may or may not even go to an annual check-up. Don’t underestimate the power of your contribution “strategy.”
2) The Plan Design(s):
When discussing plan designs, given all the carriers and plans available, know that as a small group (new start-up/under 100 employees) your options are expensive and limited with or without a broker (unless you partner with a Professional Employer Organization). So be smart and educated when you choose the plans.
Choose plans that make sense for your company’s culture.
If you are going to hire millennials you probably don’t need to bother with any “Gold” type plans. The high deductible plan mentioned above will absolutely suffice and you can contribute 100% because it will cost you much less and the talent you seek will feel that you are taking great care of them by offering them “free” Medical Benefits.
Please keep in mind this is a very high-level overview of the Medical Benefits “Strategy” but I am hoping that my point will hit home: Know why you are offering Medical Benefits and use your “strategy” to your advantage. Make your “strategy” work for you and make it a tool for attracting the talent you seek. Don’t just let your Medical Benefits offering be your second largest expense—get an ROI on your Medical Benefits by implementing the right “strategy”!
Disclaimer: This article discusses general legal issues and developments. Such materials are for informational purposes only and may not reflect the most current law in your jurisdiction. These informational materials are not intended, and should not be taken, as legal advice on any particular set of facts or circumstances. No reader should act or refrain from acting on the basis of any information presented herein without seeking the advice of counsel in the relevant jurisdiction. Bend Law Group, PC expressly disclaims all liability in respect of any actions taken or not taken based on any contents of this article.