Weigh options for shares in closely held firms
Published 01/12/99

The providing of employer stock, or stock options, to employees as part of an employment benefit package often fosters a positive attitude by the employee that she has a stake in the company and therefore will work harder to achieve the business goals of the corporation. When the employer is a closely-held corporation where stock is not publicly traded, an important issue for both the employer and employee is to have an agreement as to what happens to those shares when the employment relationship terminates. Both the employer and the employee must consider the fact that the employee will not always be employed by the corporation.

Generally, closely-held corporations prefer that former employees, their heirs, or their former spouses not have the right to inspect corporate records and to have other rights that corporation shareholders generally possess. Furthermore, a former employee=s equity interest in the employer does nothing for the goal of a team effort by employees who have a stake in the employer=s business goals. For these reasons and others, employers should consider what transfer, assignment, and pledge restrictions they want on those shares prior to giving out any shares or rights to shares. Any share certificates issued should clearly identify any restrictions on transfer, assignment, and pledging of those certificates, and the employee shareholder should sign a shareholder agreement confirming the same.

The employee may also decide that, once the employment relationship is terminated, she no longer wants an interest in the corporation and the employee too can benefit from a clearly defined shareholder agreement with the corporation binding it to buy back the shares. The ability of the employee to negotiate specific terms of the buy back of the shares is obviously directly related to the leverage that an employee or prospective employee possesses. Often, the employee and the corporation should consider seeking legal counsel prior to formulating how the buy back will occur. If the corporation agrees to buy back the shares, the determination of the purchase price may be specifically stated or a formula and/or method for determining the value may be set forth. For example, some agreements may call for the repurchase of the shares at Abook value@ which may be substantially less than the actual Afair value@ to the corporation to receiving those shares back. The payment terms of the purchase price should also be specifically stated including how periodic payments (if any) of the purchase price is to be made, interest on the outstanding balance, and whether there is any prohibition or penalty on prepayment of the periodic payments.

Employees sometimes will take a salary which is less than their Amarket value@ in exchange for stock options as potential compensation. For this reason, the employee must carefully review the terms of the shareholder agreement to fully understand how the shares and value of the shares are determined. If the employee has enough leverage to negotiate and the agreement needs to be revised to protect her interests, then she could amicably negotiate those amended terms after having the matter reviewed by legal counsel.

J. Daniel Marr is a director and shareholder at Hamblett & Kerrigan, PA whose legal practice includes counseling businesses and business persons on a variety of legal issues and advocating on their behalf. Attorney Marr is also an adjunct professor at Daniel Webster College where he teaches business law. You can reach Attorney Marr by e-mail at: dmarr@hamker.com

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