One of the hardest decisions startup founders is deciding when and how to grant an ownership interest in the company to potential employees, 3Ls Rob Bean, Nick Bridge, Michael Delaney and Marco DiPrato of the law school's Entrepreneurial Law Clinic explained during a Philly Tech Week event on equity compensation. The students lead the workshop, accompanied by expert attorneys: Chris Miller of Pepper Hamilton and Steven Poulathas of Flaster Greenberg.
Bridge and DiPrato kicked off the presentation explaining how equity compensation plays a major role for any startup and enhances it's ability to align interests, retain talent and improve productivity with little cash on hand. The type of compensation issued is, therefore, an important consideration, they said. Bridge and DiPrato provided an overview of the various types of equity compensation options available to both traditional corporate entities and LLCs. Stock awards, options, phantom stock and stock appreciation rights are all options for corporate structures while LLCs enjoy similar equity options in the form of capital interests, profit interests, unit options and phantom units, the students explained.
The students also provided an in-depth discussion of the various tax implications associated with equity compensation. Both the receiving equity compensation as well as issuing the compensation can trigger a variety of taxable events depending on the type of compensation, they said. Founders should ensure that they are choosing the type of compensation that makes the most sense from a business perspective given these consequences, they added.
In the second half of the presentation Bean and Delaney discussed the importance of properly determining a company's valuation. Proper valuation can help a startup avoid future repercussions for noncompliance and also help determine not only the value of equity but also the type of equity that should be issued, they said.
There are two main levels of valuation, they explained. Ordinary valuation which is appropriate when issuing profits interest, restricted stock units and common stock, while section 409 valuation which applies to issuance of options, phantom equity and stock appreciation rights.
The students rounded out the presentation with a discussion of securities compliance issues and a more practical discussion of exactly how much equity founders should grant according to the type of employee they are trying to recruit and stage of the startup.
The Kline School of Law Entrepreneurial Law Clinic provides the legal services necessary to bring innovative ideas from conception to raising outside funding. Aside from assisting start-ups with legal services, the ELC helps entrepreneurs help themselves by regularly conducting free workshops like this one on cutting-edge legal topics relevant to the start-up community.