When you first form a corporation, the founders buy stock at a very low price. At some point in the future when you start adding on people, they can pay that same low price for the stock because that’s the value of the stock. Later on, however, when you first have an outside investor come in to purchase stock at a higher value, you reset the value of the company. Your new people who you give stock to have to look at the valuation to see how much they’re going to have to pay for that stock. Often they don’t want to pay the determined amount. So, instead you give them stock options. In either case, you would have vesting for them over time based upon accomplishments, timelines and milestones. The tax differences between owning stock at the beginning and having stock options that you exercise later on are very significant. If you want to hold your stock after you’ve exercised your options and received it, for 12 months, you don’t get capital gains tax treatment. That tax treatment means you pay about half the amount in taxes. There are ways to work through these issues that you need to think through, every time you have a new shareholder come in who’s getting stock for work that he does. You have to be very thoughtful about it because the tax consequences can be very significant.
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