In today’s tight labor market — as evidenced by a four percent national unemployment rate in January, according to government data — employees increasingly have a choice about where to work; and salary alone isn’t always enough to attract and retain talent.
Secaucus-based Freshpet, a publicly traded all-natural pet food manufacturer, has been aware of that for some time, and accordingly adjusted its compensation program, said Don Heisey, the company’s vice president of human resources. “For some years now, salaried employees have been eligible for equity compensation,” he said. “As of February 1, hourly workers who have one year of service were also eligible for restricted stock units. We believe that all team members contribute to Freshpet’s success, and all should share in it, too.”
Restricted stock units, or RSUs, are different than stock options, and the tax treatment may differ too, but both have the effect of giving workers an equity interest in their employer. In addition to the RSUs, the benefits package for Freshpet employees has long included medical, dental and vision coverage, along with perks like life insurance, pet health insurance and a 401(k) with a dollar-for-company contribution match up to four percent the employee income. At the company’s Secaucus location, workers can avail themselves of free, healthy – human – food at any time, while workers in its Bethlehem, Pa. location can get lunch at no cost.
“We also offer free pet food for employees’ dogs and cats at both locations,” added Heisey. “The main reason we offer these benefits is to reward team members for their hard work, but a byproduct is the ability to attract and retain talented employees. We recognize that the unemployment rate is near an all-time low, so it’s a very competitive market for labor. We believe that a combination of benefits, work environment and compensation acts as a competitive advantage.”
Consider the regulations
Startup companies and others that use heavy-duty stock options and other non-cash incentives, like cryptocurrency, have to be careful of securities and IRS regulations, according to Joel E. Horowitz, a partner with the law firm McCarter & English LLP whose focus includes employee benefits and executive compensation.
“We recently represented a New Jersey company in connection with its initial public offering,” he said. “The SEC commonly reviews IPOs to make sure that any transactions involving stock, including equity grants, leading up to the IPO were at a fair price.”
Equity awards issued to employees at less than fair value may be considered grants of “cheap stock,” he added, which could complicate valuation, reporting and other issues for the company and, potentially, the employee. “The SEC focuses on this during an IPO to ensure that companies are accurately reflecting compensation charges in their earnings,” Horowitz added. “One way to establish fair value is to engage an independent valuation expert, but it also makes sense to revisit that valuation for purposes of new awards as the company gets closer to the IPO date.”
Once a company’s publicly traded, its shares are easy to value — just look at the listed stock price. But by definition, it’s not so straightforward for a pre-IPO company. Such a business, usually a startup, isn’t required to get a third-party valuation, but if it does, there’s generally a presumption that the valuation is accurate and valid for up to a year. But there are exceptions.
“Say you get a third-party valuation of $2.50 a share at the end of December,” Horowitz said. “Then in June of the next year, still pre-IPO, you sell shares to a new investor at $5 a share. Come December 1 you grant employee options. You’re still within the one-year window, but it could raise questions if you priced the latest shares at the old, $2.50 valuation, when the latest arms-length value was $5 a share. In a case like that, it may make sense to rethink your valuation.”
A crypto wrinkle
Some technology companies issue cryptocurrency as a way to attract and retain talent without draining their bank accounts. “At this point it seems to be okay to compensate employees or independent contractors in cryptocurrency,” he noted. “It’s taxed as ordinary income when paid as compensation.”
There’s a wrinkle, though, if a company issues options on cryptocurrency instead of stock options. Cryptocurrency options, like stock options, are generally subject to ordinary income tax when exercised, But when crypto-options are exercised, an additional 20% penalty income tax may be triggered, “unless the option is very carefully structured,” Horowitz cautioned. “Even then, options on cryptocurrency are much less flexible than stock options in terms of when they can be exercised.”.
It’s not unusual for companies to get tripped up with these and related issues, he added. “Startups and early stage companies aren’t in business to keep track of tax laws. They’re trying to attract talent but may not always be able to offer market-level compensation, so they often offer options.”
As with many issues, early preparation can help a company to steer clear of a lot of grief later on.