Publically traded companies can offer stock or stock options to an employee as incentives. This makes the employee, in a small way, part owner of the company and could provide them incentive to work harder.
Is there anything equivalent that a privately held company can offer employees?
Something that increases in value as the company becomes bigger and increases in value?
They are called…stock options. Companies don’t have to be public to have stock. I used to work for a privately held New England supermarket chain. They got sold to another private company and gave me significant stock options right before the deal was final. They paid out just like any other stock options do and they were treated that way for tax purposes. I hear it can be more difficult to value those shares for a basis however.
I later went to work for a software company and got stock options there as well. They wouldn’t have to go public for them to have value. They would mainly just need to be sold to somebody even if it was a private sale.
Here is an article about public versus private stock:
Really?
Does the company just arbitrarily decide how many shares they have?
How is the value of each share determined?
How is the price of each determined if not by the marketplace?
If you cash them in, is the company required to buy them back from you?
Sorry for all the questions, I’m pretty clueless about such business things.
Thanks for the article.
It sounds like a company might offer some private stock to employees as bonuses, but only if they were already initiating private equity stock sales to investors.
When I was creating my company, I evaluated several options for how to form it: S-Corporation, C-Corporation, Partnership, Sole Proprietership, LLC, etc. Some of these allow or require you to have stock.
Yes, you pretty much just arbitrarily decide how many shares to have, although there’s a process you need to go though to make more after the original formation of the company.
It’s less a matter of “price” of each share as the more fundamental idea of percent of ownership. Generally distributions of dollars and the like to owners is done proportionally to share ownership. Owning more shares just gives you a bigger piece of whatever pies the company decides to produce.
I ended up not going a route that required share ownership, so I don’t know the details. In particular, I can’t tell you how you’d create more shares, or how you’d do something like options, although Shagnasty’s article talks about it in very general terms.
This is the only one that wasn’t really hard. No, stock options won’t get bought back by the same company. Private stock options only have value when an outside entity wants to buy the company and the company usually just reabsorbs them when someone quits or get fired.
The value of any stock option is determined what is called the “strike price” versus the sale price of the stock. The strike price is related to the market value of the company when the stock option is given. The sale price is determined in negotiations in the sale.
Here is an example. The private company DolseLunards is founded in 1980. They offer 1000 shares of stock options to all key new employees. These employees have to stay with the company until it is sold for those to have any value at all.
Mary starts in 1985 and her stock options are struck at estimated market value of $1
Skip starts in 1995 when the company is flying very high and his stock options are struck at $100 a share.
Jane starts in 2004 and her stock options are struck at $50 a share.
The company is doing well as of 2006 and private investors want to buy it at $90 a share. Sold.
Here are the payouts:
Mary gets (90 - 1) * 1000 = $89000
Skip gets nothing because his stock options were initially priced above the sale price. In theory, if he forced a sale of his shares he would owe much money but stock options don’t work that way. They are risk free from that angle.
Jane gets (90 - 50) * 1000 = $40000
After taxes, Mary and Jane will lose some of this to capital gains taxes but stock options were a risk free investment to them and they had some incentive to stay with the company if they had any hope at all of cashing in on them.
Another option would be profit sharing. Basically, the company says “X% of all profits over Y amount will be set aside as bobuses for our employees”. That X% can be distributed equally, objectively (ie, seniority), subjectively (ie, employee value to the company), or whatever means the owners decide.
Bobuses? I think I meant “bonuses”.
At our private company, a team of accountants descends upon us every year to establish the overall valuation of the company. They and our financial team argue for months about what companies are comparable to us, likely trends in the future and so on. When the number is agreed on, the rest flows. Divide valuation by shares, send out checks as needed.
I am not sure these are technically called stock options. SROs? So it may not strictly answer the OP, but it is one way for a private company to give their employees incentives and ownership.