Article
8 min read
Author
Jemima Owen-Jones
Published
August 16, 2021
Last Update
June 28, 2024
Table of Contents
The benefits of giving equity to contractors
The disadvantages of giving equity to contractors
Step 1: Decide on the best types of stock options for your contractors
Step 2: Decide how much equity to give to contractors
Step 3: Choose how to structure equity incentives
Step 4: Draft an equity agreement, also known as a stock option grant
Step 5: Educate your contractors
Step 6: Fulfil your tax reporting obligations
Grant contractors equity with Deel
Attracting and retaining independent contractors worldwide is a top priority for business owners and entrepreneurs looking to source flexible and highly skilled talent. A successful tactic to outplay the competition and source talent within a budget is to offer contractors equity in your company.
Equity, also known as stock, represents a claim of ownership of the assets and earnings of a company. Companies typically grant stock options that, if conditions are met, can be converted into company shares. When this happens, the contractor becomes a stockholder.
Disclaimer: This content does not constitute legal advice. Please consult a legal professional for guidance on your specific case.
The benefits of equity—in addition to ordinary income—for both contractor and hiring companies are significant:
Equity incentivizes contractors to renew their independent contractor agreements instead of looking for new clients
Equity allows contractors to reap some of the value they’ve helped create
Equity is less expensive for early-stage startups to give as compensation since its true value accumulates over time
Companies can gain access to the talent they would otherwise be unable to afford by partly paying them with equity
The disadvantages of equity compensation for contractors and hiring companies are as follows:
This article will guide you through the steps in providing contractors with equity.
The type of equity you choose to provide to contractors will depend on the stage of the company, whether you have raised a priced round during an external 409A valuation, and where your contractors are located.
The different types of equity are as follows:
💡 Deel lets you offer almost any kind of equity or token plan to contractors and can help you choose the best option for your business.
You can’t offer contractors incentive stock options (ISOs), as they can only be granted to direct hires of your company.
See also: How to Grant Stock Options to Foreign Employees
Once you’ve settled on the type of equity you want to provide, you need to decide how much equity to give to contractors.
How much will depend on numerous factors such as:
Determining equity stakes for contractors can be more challenging than for employees. Unlike employees, contractors are usually hired for a specific project or designated period. Their commitment level will differ, and your control over their work will be significantly less.
For each contractor, try to set your baseline as the minimum amount you need to offer that contractor to incentivize them. With that in mind, you’ll also need to consider that equity has more of a risk factor than cash incentives. The percentage you ultimately land upon depends on how valuable the contractor’s work is to your company and the market demand for their skillset.
The next step is to devise a stock option plan to structure your equity incentives so they benefit both the contractor and the company.
Here are a few common equity structures for contractors:
The best structure will depend on the contractor’s lifecycle and the complexity level you’re willing to take on. For example, a milestone structure is harder to implement since contractors typically work in shorter cycles. You’d need to define product delivery, which can be more ambiguous from a legal standpoint.
💡 Deel’s equity experts can advise you on the best equity or equity-like structure for your contractors.
In some countries like India, equity grants to non-direct workers are forbidden. We have this knowledge and can advise you on offering phantom shares or other cash equivalents as an alternative.
Once you’ve worked out all the details, it’s time to devise an equity agreement that discloses the contractor’s rights to purchase equity at your company.
An equity agreement should include the following components:
💡 Deel’s HR platform supports the end-to-end workflow of creating and approving a new grant offer for a contractor.
Via the Deel platform, you can:
Once you’ve proceeded with the contract creation and the contractor signs the contract, you will be able to see all grants in one place and generate a report for all active plans and their compensation schedules.
Contractors will receive information about their grants during the onboarding process and can view all past and current grants and their details on their dashboards.
It is up to the contractor to determine whether they will give up some of their money in return for company equity. And for many, equity will likely be a new topic, full of new and complicated terms and concepts.
Before a contractor accepts and signs their equity grant, they’ll need to know what it is, how it could benefit them, and how purchasing equity could impact their tax treatment and financial standing.
Equity without the right context can be counterproductive because the economic benefit of ownership (especially with private companies) isn’t intuitively obvious.
For a baseline level of knowledge, contractors need to understand the following:
With the right education, getting equity means getting a potentially valuable asset that can bring contractors significant long-term financial benefits. Without it, it can mean missed opportunities and tax consequences.
Companies should compile educational resources to help their contractors understand the terminology, processes, clauses, and obligations.
💡 Deel has educational resources on hand, such as our Stock Option Basics Guide, that you can share with your contractors to get them up to speed.
Providing company equity can result in a taxable event for the contractor and form filing responsibilities for the company, depending on the type of equity awarded and the contractor’s country of tax residence.
In the US, for example, if the fair market value of the shares increases from the exercise price in the initial share award to the contractor, the contractor must pay taxes under the alternative minimum tax regime (AMT).
If the US contractor can exercise their shares early, the contractor must submit a copy of form 83(b) to the Internal Revenue Service (IRS) and the company; the company must retain a physical copy.
The company must also file other IRS forms in other scenarios, for example, when it has issued $10m in options in one calendar year.
If the fair market value remained the same as the exercise price when the company granted the shares, there is no taxable event.
If a company “gifts” a contractor shares, this is a taxable event. The company must distribute the correct tax forms so that the contractor can report these earnings as miscellaneous income. This process is the same for most countries.
💡 Deel can assist you with local tax authority requirements, including:
For legal, finance, and HR teams, navigating equity locally and internationally can be complex, with regulations varying between jurisdictions.
With the help of our team, you can offer competitive incentives to your employees and contractors all over the world in various forms of equity or token grants. Our local experts work to secure an optimal legal and tax framework for Deel clients, providing guidance around handling all applicable taxes and withholdings, and assisting with reporting requirements.
Whether you have general questions about equity compliance or need help navigating new global equity options, our experts are here to help. Get in touch with our team today.
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