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:
2. Equity Plans – Stock Options and Restricted Stock
3. Stock Option Plans
4. Restricted Stock Plans
5. Company Buy-Back and Repurchase of Stock Options and Restricted Stock ◄You are here
6. Cash Plans, Phantom Stock Plans and Stock Appreciation Rights
7. Summary and Plan of Action
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.
You should hire an 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, Business Lawyer. From there you can link to other pages and articles of interest.