QUESTION ON How to Issue Employee Stock Options for an S-Corporation
We have a small S-corp with 3 partners. Two of us have 35% and one has 30%. We hired an employee in March of 2007 and promised him we would each give him 2% after he’d been with us for a year. What are our options in doing this? Do we have to make him a partner or can we just give him the 6% and have it in writing? Thanks!
– Julie Statler
As a small company with three owners, there is a natural tendency to refer to fellow owners as partners
But an S corporation is not a partnership. As with any other corporation, the owners of an S corp are shareholders who own company stock and have all the voting rights associated with the stock that they own.
The procedure for issuing shares of stock is relatively simple, as discussed below. However, the real question is whether or not you really want to transfer your own personal shares of stock to this individual. This is not the way bringing on a new shareholder is traditionally done, and doing so may have potential tax consequences (see a CPA for clarification). Since the employee will presumably receive stock in exchange for services rendered to the corporation, it would make the most sense to have the corporation issue shares to him.
It sounds like your corporation does not currently have any corporate shares left to issue, since the combined shares owned by the current shareholders equal 100% of the corporation’s total authorized shares. In this case, what you can do is approve an increase in the number of total authorized shares of stock and then approve and file an amendment to your corporation’s articles of incorporation with the secretary of state in the state of incorporation to reflect the new number of total authorized shares–and then issue shares to the employee. As you decide on the amount of increase, consider that you may want to bring on additional shareholders later and/or set up an employee stock option plan to entice new employees in the future; that way, your pool of shares will be large enough to accommodate these situations.
The number of issued shares does not have to equal the total number of authorized shares of corporate stock. A corporation can have both “issued” and “outstanding” shares. What matters is who owns the issued shares, whether or not they are majority shareholders, and what their voting rights are (in the case of an S corp, there can only be one class of stock, so the voting rights would be the same for all shareholders).
The directors of a corporation are normally responsible for issuing shares of corporate stock, so it is through a board resolution that you would document the issuance of stock to your new employee in accordance with your corporate bylaws. You might also issue a stock certificate as evidence of his ownership of the shares.
As a reminder, S corps are subject to shareholder limitations; for example, an S corp can have no more than 100 shareholders, and those shareholders must be U.S. citizens or resident aliens.
Recommended Resources on How to Form LLC:
- LLC or Corporation?: How to Choose the Right Form for Your Business
- Surprisingly Simple: LLC vs. S-Corp vs. C-Corp Explained in 100 Pages or Less
- Nolo’s Quick LLC: All You Need to Know About Limited Liability Companies
- Form Your Own Limited Liability Company