Wednesday, February 27, 2008

Employee Stock Option Plans

Here is a question that was sent by a reader to Karen Klein, a columnist at the LA Times. Karen contacted me for a response because of some work we had done in Newsday:

I am starting up a Web-based business and I'm leaning toward incorporation rather than LLC as the legal entity because I'd like to be able to attract employees by issuing stock in the future. I understand that there must be a board of directors in a corporation, and the board must hold meetings and vote to bring about actions. At this initial stage my company is just myself. Therefore I'm wondering if a one-person board of directors can legally exist, and how it can perform functions such as voting.
KC, Elkridge, MD


Great question.

This is a common misconception that many small business owners have and it prevents a great deal of them from incorporating even though that may be their best option.

Owning a corporation is not as daunting a task as you think. The common concept of a “board of directors” is not what is required for a small corporation. As the 100% owner of the business, you can act as the corporation’s sole director. You must hold an annual shareholders meeting during which minutes must be kept, a task that proves fairly easy for you as the sole shareholder.

Back to your statement about issuing stock to employees...

Although Employee Stock Ownership Plans (ESOPs) are typically a better fit under the C-Corporation structure, as a “solopreneur,” you should gain much greater tax advantages by operating as an S-Corporation (depending on your income level, you may be able to cut your total tax in half). Additionally, as the IRS continues to tighten their reigns on the tax laws surrounding stock options, ESOPs become less attractive to potential employees making them less likely to accept stock or stock options in lieu of pay. If you use the taxes saved by operating as an S-Corporation to replace stock options with higher salaries, you should be able to attract quality employees, retain full control and ownership of your company, and still have money leftover to pay yourself or reinvest in the business.


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