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In an article posted on the SHRM website (Society of Human Resource Management), Joanne Sammer, a New Jersey-based business and financial writer, discussed the solution to pay independent contractors with Company Stocks
In some situations, companies choose to pay independent contractors with company stock in the form of stock options, restricted stock, or outright stock grants. This is particularly common among startups that do not have access to a lot of cash or private companies that intend to be publicly traded in the future. However, companies can offer stock to any independent contractor.
In deciding whether it is a good idea to pay an independent contractor with company stock, companies should consider two key strategic issues by making sure that:
- Contractor ownership of stock (whether through a restricted or outright stock grant or stock options) does not create a conflict that pits the contractor’s interest against the interests of the company or the other shareholders.
- The amounts of stock involved never represent a large enough percentage of the company to create an issue over who controls the company.
There are several elements to consider when developing a stock-based compensation agreement with a contractor. No matter what the situation, companies should consult with tax and legal counsel to make sure these arrangements comply with laws and regulations and to understand the full tax consequences for those involved.
In many cases, stock-based compensation arrangements involve consultants the company hires for a specific project. It is up to the contractor to determine whether he or she is willing to give up some cash payment in return for some form of company stock. For example, if a consultant earns $100 an hour, a company might offer to pay $90 in cash and $10 in stock…
The reasoning behind the offer is clear. When a consultant is handling a technical role that is important to the company or is working close to full time over several months, offering stock can reduce the cash outflow required to pay for that consultant. There is also the hope that contractors will be more invested in the outcome when they are paid partly in company stock.
The type of stock to offer to contractors is an important decision for businesses. “Most companies would prefer to grant a simple regular stock option with provisions similar to the stock options they grant their own employees, which typically involve a four-year vesting period,” said Beck. However, not all contractors are willing to accept that as compensation for several reasons, including the cost of exercising stock options and any tax implications. In these cases, companies may be able to seek out a middle ground, such as offering a shorter vesting period of one or two years or changing the arrangement to a restricted stock grant. But if the agreement in the company’s formal stock option plan forbids changes to vesting schedules, the organization could focus negotiations on the number of shares awarded or the terms under which shares vest.
One issue to consider is how to determine the price or value of shares if the company is private and there is no market for the stock…
Companies need to determine what happens to stock-based compensation when they formally terminate a contractor relationship. “I encourage companies to prepare a simple form letter that goes to the consultant reminding them of the responsibility to exercise the stock option within the required window,” said Beck. “This is the same kind of letter a terminated employee would receive. In both cases, the individual has to either exercise [the] option or lose all rights and privileges of the option” after a certain time.
One final issue to keep in mind when offering an independent service provider stock-based compensation is any potential effect on that party’s classification as a contractor…
Determining employee or contractor classification focuses on basic and subsidiary questions that are not defining in themselves but can weigh in on one side or another.
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