MIRSKY & COMPANY, PLLC

T EL : (202) 339-0303 (DC) (646) 374-1335 (NY) F AX : (202) 350-9480 E MAIL : ANDY @M IRSKY L EGAL . COM I NTERNET : WWW .M IRSKY L EGAL . COM

New Media Legal Breakfast (Twitter: #MediaLawDC) January 26, 2012 Equity Ownership Options Andrew Mirsky, Esq. (Mirsky & Company, PLLC) Andrew Cooper, CPA (Quinn Lobel & Associates, P.C.) Stock Options 1. Incentive Stock Options (ISOs) Issuable only to employees (no contractors, freelancers, vendors, etc.) Grantee must hold option for at least 2 years and underlying stock (i.e. post-exercise) at least 1 year after exercise (IRS requirements). Pros (for employees): Not taxed upon grant, not taxed upon exercise. Taxable only upon disposition of underlying stock. Therefore, if never exercised, never taxable. Tax calculated based on appreciation between exercise price and price at disposition. Tax is long-term capital gain (i.e. not ordinary income). Pros (for Company): Options are not stock grantees are not true shareholders, but get semblance of ownership without Company giving up ownership rights. For key employees, incentivizes success of Company and thus improve spread between stock value and exercise price. Company can implement vesting terms with same effect as forfeiture (same as restricted stock). Cons (for employees): Same as pros for Company: Grantees not true shareholders. Holding period (2 yrs post grant and 1 yr post-exercise) can be difficult. Potentially worthless if stock value depreciates. Must be exercised within 3 months of termination of employment (otherwise, gets treated as NSO Cons (for Company): No deduction for compensation. 2. Non-Statutory or Non-Qualified Stock Options (NSOs or NQOs) Issuable to employees and non-employees (including contractors, freelancers, vendors, etc.) Pros (for employees): Not taxed upon grant, BUT taxed upon exercise. Taxable upon disposition for post-exercise appreciation as capital gain. Pros (for Company): Company gets deduction for compensation upon grantees exercise.

2301 N Street, NW (Suite 313) Washington, DC 20037

318 West 14th Street (4th Floor) New York, NY 10014

MIRSKY & COMPANY, PLLC

Options are not stock grantees are not true shareholders, but get semblance of ownership without Company giving up ownership rights. For key employees, incentivizes success of Company and thus improve spread between stock value and exercise price. Company can implement vesting terms that effectively cause forfeiture (same as restricted stock).

Cons (for employees): Same as pros for Company: Not true shareholder. Potentially worthless if stock value depreciates. Taxable upon exercise (unlike ISOs): Ordinary income to grantee upon exercise. Tax = Excess of (i) FMV of underlying stock (at exercise) over (ii) exercise price. Cons (for Company): From Companys perspective, few cons. * * *

Restricted Stock What is restricted stock? Stock (i.e. actual stock, not options) that is substantially nonvested, meaning: (1) Subject to substantial risk of forfeiture, i.e. subject to repurchase at less than FMV if employee leaves Company, and (2) non-transferable, i.e. may not be transferred without risk of forfeiture. Issuable to employees and non-employees (including contractors, freelancers, vendors, etc.)

Pros (for employees): Grantee becomes actual shareholder immediately: Stock is actually issued to the employee (or non-employee), subject to vesting and Company repurchase rights. No income tax upon grant until vesting restrictions lapse. Employees have option (Section 83(b) of Internal Revenue Code) to elect to recognize income immediately (rather than post-vesting and post-appreciation) upon grant based on FMV of underlying stock downside is pay tax now, but at potentially lower rate than later. Unlike options, grantee is true shareholder with all rights of owners (voting rights, distribution rights, information rights, etc.). Pros (for Company): S corps typically require restricted stock recipients to make Section 83(b) election. Otherwise, employee owns stock but may not be responsible for taxable share of profits. So dilutes taxable income of all owners. If employee makes 83(b) election, Company gets deduction for compensation. Company can implement forfeiture and repurchase terms allowing buyback at cheap cost. Structure more flexible than options, since options (particularly ISOs) must comply with IRS rules (exercise price setting, minimal holding periods, etc.). Both options and restricted stock can have vesting periods, during which time theyre both subject to forfeiture. Cons (for employees): If stock has value, employee required to pay $$ for purchase (unlike options). However, with new companies with startup value, stock may not yet have value, so cost may be negligible. If employee receives restricted stock and makes Section 83(b) election, still not protected against forfeiture or repurchase by company. Cons (for Company): Employees become stockholders immediately, subject to forfeiture, but full shareholder rights nonetheless, which may or may not be desirable (voting rights, distribution rights, information rights, etc.).
Page 2