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Stock Option Plans, Restricted Stock, Phantom Stock and
Other Incentive Plans
for Closely Held Businesses
Article #5 – Company Buy-Back and Repurchase of Stock
Options and Restricted Stock
This series of
articles explains how restricted stock, stock options, cash
plans and phantom stock really work for closely held
companies, and what their real value is for the company and
the employee.
The
articles in the series are:
Where You Are in the Series
In this article
#5, I explain how you take back an employee’s stock when the
bum quits or you fire him. In the previous articles #3 -
Stock
Option Plans and #4 -
Restricted Stock Plans, I introduced stock option plans
and restricted stock plans.
Don’t forget
article #2,
Equity Plans – Stock Options and Restricted Stock. In
that article I introduced ten basic concepts for all equity
plans, including restricted stock plans. You should
understand the ten basic concepts before moving on to this
article.
Buy-Back of Stock
Now we’re getting
to the good stuff – the key to how closely held companies
should use restricted stock and stock options. The problem
is this: the employee receives stock but later leaves the
company. The employee becomes a minority shareholder who no
longer has an everyday stake in the company. Remember from
article #2,
Equity Plans – Stock Options and Restricted Stock the
essential nature of all shareholders – they are a pain. The
situation is worse if the employee leaves the company on bad
terms.
The solution is
for the company to buy-back the employee’s stock when he
leaves the company. The company’s buy back right would
apply to all shares, even vested shares. The buy back right
would apply when the employee leaves the company for any
reason whatsoever. So when the employee says “bye” you say
“buy-back.”
The Buy-Back Price
In buying-back an
employee’s shares, the real issue is the repurchase price.
California law prevents a company from taking back an
employee’s shares for free. You have two choices here: (1)
pay the original purchase price for the stock or (2) pay the
current fair market value of the stock at the time of the
buy-back. Assuming that the company will grow and increase
in value, the original purchase price should be lower than
FMV at the time of buy-back.
Which price do you
pay? In brief, you pay original purchase price for
unvested stock and FMV for vested stock. The bottom
line is that when the employee leaves, he loses all his
shares. But you pay him a fair price for the shares. Hence
you return the money (if any) the employee gave you for
unvested stock; and you pay the employee FMV for his vested
stock. Note that your documents should give your board of
directors the exclusive right to determine FMV.
Shameless Plug
You should
hire a securities attorney to help you with your stock
option plan or restricted stock plan.
It’s expensive to
have me fix a bad plan; it’s cheaper to do it right the
first time.
If you want
to read more try my main page,
Securities
Attorney. From there you can link to other pages and
articles of interest.
Call me to schedule a legal consultation:
510-796-9144 | 