Comparison of Equity Grant Structures

We are often asked to provide an explanation as to the different types of non-cash compensation that are traditionally granted to employees of a company. The following provides a high level summary.

OUTRIGHT EQUITY GRANT

Ownership:  Outright ownership fully vested as of the date of grant.  Can be subject to claw back (i.e., repurchase) by the company pursuant to the terms of the Operating Agreement.

Voting:  Has full voting rights.

Allocated Share of Profit/Loss:  Pro rata right to share in the profit and loss of the company based upon percentage ownership.

Underlying Enterprise Value:  Has all underlying enterprise value from inception.

Tax Treatment:  Taxed to recipient as ordinary income upon date of grant based upon fair market value.  Disposition after twelve (12) months will be taxed at capital gains rates.

RESTRICTED EQUITY GRANT

Ownership:  Vested as of date of grant but subject to a risk of forfeiture (i.e., vesting based upon time and/or performance conditions).

Voting:  Can have full voting rights.

Allocated Share of Profit/Loss:  Can have right to share in the profit and loss of the company based upon pro rate ownership.

Underlying Enterprise Value:  Will have full enterprise value attributable to it, subject to certain tax limitations set forth below.

Tax Treatment:  Within thirty (30) days of grant, recipient to file Section 83B election which will allow recipient to report the value of the grant at a discount of fair market value due to risk of forfeiture.  Tax will still be due on the discounted fair market value which will be treated as ordinary income.  Provided the equity is held for at least twelve (12) months, tax treatment on disposition will be capital gains.

PROFITS ONLY INTEREST.

           Ownership:  Immediate ownership upon grant.

Voting:  Full voting rights.

Allocated Share of Profit/Loss:  Has right to receive allocated percentage of profit that is earned after the date of grant.  No right to any retained earnings or profit from operations prior to date of grant or to allocation of losses arising from operations prior to date of grant.

            Underlying Enterprise Value:  Has no underlying enterprise value.  (i.e., as of the date of grant has zero value).  Accumulates pro rata percentage of enterprise value that is created after the date of grant.

Tax Treatment:  No taxable income to recipient as of date of grant.  Equity held for at least twelve (12) months from date of grant will be taxed at capital gains rates upon disposition.

PHANTOM EQUITY

            Ownership:  No ownership in the equity of the company.  Solely a contract right to receive a transaction bonus upon liquidation of the company.  Must be employed by the company at the time of liquidation to receive the transaction bonus.

Voting:  No voting rights.

Allocated Share of Profit/Loss:  No right to participate in profit and loss.

            Underlying Enterprise Value:  Has full underlying enterprise value upon grant.

Tax Treatment:  Taxed as ordinary income as it is treated as a transaction bonus at the time company is sold.

OPTION GRANT

Ownership:  No ownership as of date of grant.  Ownership upon exercise of the option.

Voting:  No voting rights until the option is exercised.

Allocated Share of Profit/Loss:  No right to share in profit and loss until the option has been exercised.

            Underline Enterprise Value:  Option is granted at fair market value which requires the recipient to pay an exercise price to acquire the underlying equity.  Since the option has a fair market value strike price, as of the date of grant it has no participation in the underlying enterprise value.

Tax Treatment:  No tax incurred on date of grant.  Upon exercise, ordinary income will be recognized at the difference between the then current fair market value and the strike price.  If option is exercised at least twelve (12) months prior to a liquidation event, disposition of the equity will result in capital gains treatment.