Direct Stock Purchases in Closely Held Companies

February 2015
David R. Johanson
NCEO: Equity Alternatives (13th ed.)

Sometimes a closely held company that wishes to permit employees to purchase company stock may desire greater flexibility and discretion than is allowed under a government-endorsed (“statutory”) stock ownership program. This chapter explores alternative forms of motivating employees to improve a company’s productivity and profitability through incentives that involve the direct purchase of company stock in closely held companies by employees outside of the traditional methods provided under Sections 422 (incentive stock option plans) and 423 (qualified employee stock purchase plans) of the Internal Revenue Code of 1986, as amended (the “Code”). It also discusses restricted stock concepts as they relate to such direct stock purchases, and it briefly addresses bonuses of company stock to employees. The direct purchase of company stock by an employee is typically based on the discounted and/or book value of a company’s capital stock. This concept will be examined from the following fundamental perspectives: (1) valuation, (2) design and structure, (3) tax implications to the sponsoring company and its employees, (4) financing and/or funding, and (5) securities laws. Please note that although this chapter focuses on stock-based programs, the same concepts generally apply to limited liability companies in which membership interests are granted in lieu of company stock.

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