In certain cases, organizations opt to pay independent contractors with company stock. This can include outright stock grants or restricted stock. It is common among new businesses or start-ups as they lack access to an extensive pool of cash. This is also evident among private companies willing to trade publicly in the near future. However, organizations can offer stock to any independent contractors.

When deciding whether to pay an independent contractor with company stock, organizations should consider two key strategic issues:

Contractor ownership of stock, whether through a restricted or outright stock grant or stock options, should not create a conflict that pits the contractor’s interest against the company’s or other shareholders’ interests.

The stock involved never represents a significant enough share of the corporation to raise concerns about who controls it.

There are various factors to consider when creating a stock-based compensation arrangement with a contractor. Whatever the case, businesses should engage with tax and legal advice to ensure that these arrangements conform with laws and regulations, as well as to understand the entire tax implications for all parties involved.

Who Can Get the Stock?

In many scenarios, stock-oriented compensation arrangements involve the company’s consultants hired for a specific project. The contractor determines whether he or she is eager to give up some of the cash payment in return for the company stock. For instance, if a consultant earns approximately $100 an hour, an organization might offer to pay $90 in cash and $10 in stock. This offer is a pitch to the consultant, from the organization’s perspective.

The reason is clear here. When a consultant has been working close to full-time for over a couple of months or is handling a technical role that is crucial for the organization, offering company stock can decrease the cash outflow essential to pay for that consultant. Moreover, when they are paid partly in the organization’s stock, there is hope that the contractors will be highly invested in the outcome.

What Type of Stock to Offer?

This is a critical decision for businesses. Most corporations would like to grant a simple regular stock option with provisions equivalent to the stock options they grant their personnel, which typically involve a four-year vesting period. However, not all contractors are ready to accept it as pay for a variety of reasons, including the potential tax implications and the cost of exercising stock options. In this regard, organizations may be able to find a medium ground by granting a shorter vesting period of one or two years or converting the arrangement to a restricted stock grant. However, if the agreement in the organization’s formal stock option plan prohibits changes to vesting schedules, the company could emphasize negotiations on the terms under which shares vest or the number of shares awarded.

How To Set the Price?

One problem to examine is how to calculate the price or value of shares if the company is privately held and there is no stock market. In this case, the IRS demands a 409a valuation to determine the value of the shares awarded to the company’s workers, as well as the price for any stock-based compensation paid to independent contractors.

What are the pros of offering stock options to contractors?

Here are the following benefits:

1. More capital

If you’re on a tight budget or building your business with loans from friends, family, or savings, providing stock options is an excellent approach to lower your current capital requirements.

2. Increased contractor loyalty

Offering stock options makes it evident to your contractor that you value their work and are eager to invest in their future.

3. An invested workforce

When your contractors understand that they will directly profit from your success and share in your failures, they will be more invested and determined to execute to a high quality.

4. A more equitable and diversified workforce

Offering stock options to your workforce, regardless of where they live in the world, gives you the ability to change global wealth inequality, particularly after retirement.

The drawbacks of offering equity to contractors

Consider the following disadvantages of offering stock options to contractors.

1. Possible conflicts of interest.

Contractors may emphasize brief stock gains over the company’s overall health and goals. They may redirect strategies or influence choices in a way that benefits them personally.

For example, they may prioritize projects that are related to stock values over those that are not.

2. Dilution of control

Each share issued to a contractor diminishes the amount of equity held by the company’s existing stockholders. This can change the decision-making dynamics within the organization and hinder future investment negotiations.

Investors may likewise be unwilling to invest in an organization with a large number of non-employee shareholders.

3. Compliance and misclassification risks

Stock option agreements should be carefully structured. It must be apparent that the contractor is not treated as an employee. This frequently necessitates additional clauses and specific language. Misclassification can result in legal penalties, back pay for benefits , and other tax liabilities.

4. Increased administrative burden

It necessitates the corporation maintaining detailed records, adhering to legislation in different countries, and updating legal documents regularly. This might put a strain on its resources and draw focus away from its primary business operations.

How To Manage the End?

Organizations must establish what happens to stock-based compensation when they officially end a contractual engagement. Companies should develop a simple letter that informs the consultants about their obligation to exercise the stock option within the designated window. This is the same type of letter that a terminated employee would receive. In both circumstances, the individual must either exercise the option or lose all rights and benefits associated with the choice after a period.

Why Consider Classification Issues?

One final consideration when granting stock-based compensation to an independent service provider is the potential impact on that party’s contractor status. This is not only about the IRS. The classification issue is of importance to several enterprises, governments, and regulatory authorities.

Paying in stock becomes one of the considerations to evaluate because it might reflect a relationship closer to employer/employee than company/contractor, posing the possibility of contractors being reclassified as employees.

Bottomline

Offering equity or stock options to contractors is a powerful strategy for attracting and keeping top talent. By understanding the different types of stock plans and the legal considerations, you can implement these incentives.

Basta & Company can help you with these, and even more factors to consider when offering stock options to contractors. Get in touch with us today.