A stock option plan is an option to give the key employees more incentive to stay with your company and potentially purchase your company. Usually the owner will sell to the employee (or employee group), 10%-25% in total. The amount of the stock will always be less than the majority of the stock.
The key person has a better chance of financing future stock purchases from financial institutions by owning this amount of stock in the company. This creates the building blocks of a future sale for the current owner.
This percentage of ownership doesn’t give the key employee control of votes during shareholder meetings. The majority owner can maintain control over the voting as long as the Articles of Incorporation and the Bylaws have been properly structured.
Another options is to issue only non-voting stock to the key employee(s) in Tier 1. By amending the corporations’s Articles of Incorporation, you can issues non-voting shares. You can even do this with S corporation. The one class rule of an S Corp does not apply as non voting stock is not considered a second class of stock for purposes of this rule.
CONTROL IN SELLING YOUR COMPANY
Usually corporate laws generally require at least two-thirds approval by the shareholders when the corporation has a major event as selling the company to a third party. As long as you maintain at least that amount of percentage ownership, will have the ability to control the decision regarding a future sale.
Keep in mind, when an owner transfers their stock, the intent is to a)keep the key person so they can be a factor in the success of the company, b) they will be a potential purchaser (s) of your company.
However, life doesn’t always go the way we plan, and people change their minds. There should be a buy back option should there be a change of heart of a key employee becoming an owner in the future.
To protect you from this life change, you can utilize some options.
The Drag Along
Suppose you are in the position of selling your stock to an outside party, and they wish to acquire all of the stock (100%, including your co-stockholders). This can be accomplished by having a Buy and Sell Agreement which requires the co-stockholders to sell the stock based on the same terms and conditions which you negotiated for the sale of the company. This is called a DRAG ALONG PROVISION.
What if your key employees become problematic, and you want to have the ability to re-acquire the stock which was previously transferred to them. This is done through a Buy – Sell Agreement as mentioned above. Stock re-call provision.
Keep in mind, when an owner transfers their stock, the intent is to a)keep the key person so they can be a factor to the success of the company, b) they will be the potential purchaser (s) of your company, but things don’t always go the way you think they will and life has a way of changing the game. To protect you from this life change, you can utilize some options.
Helping assure key employee loyalty, while avoiding the downside risk!
Transferring stock to an employee usually involves three reasons:
- To provide an incentive to remain with the company
- To initiate the first tier of your overall exit planning
- To show a commitment to the key person (s), and in return, you expect their commitment
When a stock is transferred by the owner, it normally starts the beginning of transferring management duties to the key person(s). When the owner starts to move duties over the key person, there is also the risk that the key employee will leave, taking some customers with them, and also some of the trade secrets of the company.
This is where the owner must manage the decision of transferring stock. The owner can reduce or even eliminate the downside of the risk. The owner can have a non-compete and non-solicitation, and a confidentiality agreement. This is normally included in a Business Continuity Agreement.