Previously we wrote about equity compensation for cannabis employees from a business perspective. We have seen more and more companies adding equity to their overall compensation package, so now is a good time to review it from an employee perspective. For an overview of the types of equity compensation available, see here.
Equity Compensation for Cannabis Employees: Potential Employment Tax Issues
Many companies assume that there are federal exemptions for startups that allow them to compensate early-career cannabis employees in stock only, but that’s not the case. Minimum wage and overtime laws always apply, and the value of stocks and stock options is not included in determining whether an employee is paid at least minimum wage. This means that the employer is still responsible for remitting the FICA/FUTA employer side and state employer taxes. The employer is also an agent of the federal and state governments and is responsible for collecting federal and state employment taxes from the employee, including requiring the employee indicate the level of withholding tax that the employer should apply to the employee’s salary.
Stock-Based Compensation for Cannabis Employees: Determining the Compensation Assessment
Beyond these general salary questions, there is the question of the value of remuneration, which is different from the valuation of companies. If a cannabis business goes through a formal valuation process and is reasonably worth $1 million, that does not mean that an employee’s 1% stake in that business has a current value of $10,000.
All new businesses and an overwhelming majority of cannabis businesses are tightly owned, meaning they are wholly owned by a small group of owners. The company’s shares or interest are not openly available in the public market and may not be offered for sale unless the company registers its interests under federal securities laws. Thus, the present value of the employee’s 1% stake in a closely held cannabis business is not the same as the same stake in a publicly traded company.
Resale value is not the only measure of stock compensation held by a cannabis employee. There are also things like distribution rights and redemption rights. The devil is in the details here as it all depends on the company’s governing documents.
There is no general requirement that a limited liability company or corporation distribute profits to its owners. In fact, unless limited by the LLC operating agreement or the company’s articles of association, owners and managers can compensate themselves as salaried employees of the company, potentially eliminating any funds that would be available. for distribution.
Even in a business where this is not the case, managers often want to retain cash to use for reinvestment in the business, as opposed to distributions to owners. While this may be good for increasing the overall value of the business, it does not increase the current value of a stake that cannot be sold.
Many start-up cannabis companies can’t afford or don’t want to spend valuable start-up funds determining the exact value of stock compensation for their cannabis employees. This common scenario is not ideal for the company or the employee.
Equity-Based Compensation for Cannabis Employees: Potential Pitfalls for Employees
Cannabis employees should be wary of companies that offer stock compensation instead of any salary. Employees with equity interests enjoy certain legal protections as employees and minority owners, and they can potentially negotiate greater protections in the company’s governing documents. Many rights and protections reflect what any minority owner of a closely held company would enjoy.
If, as described above, there is concern that the owners of the business are draining cash by paying themselves excessive salaries, it is in the interest of the employees and other minority shareholders to demand that the company imposes no salary or maximum salary for owners and otherwise proportional distributions. This means that if the company is making money and the majority owners want to take money out of it, the minority owners like the employees would also receive a proportional cash distribution. This negotiation must take place before the employee accepts the compensation arrangement.
Some shares or equity interests have redemption rights, which are limited rights to force the company to redeem the company’s equity interests from the owner. If it were an immediate right to the cash, it would defeat one of the goals of equity compensation for the employer (to pay less cash and more equity at the start , while the company lacks liquidity). Many companies have set up structures to offer buyouts of all or part of the stakes held by employees or other minority shareholders, often over extended periods favorable to the company.
An additional right that employees and other minority owners can negotiate is called association rights. These are rights that ensure that if the majority owners sell part of the company to a third party, the minority shareholders can participate in proportion to their stake.
Fair Compensation for Cannabis Employees: Balancing All the Issues
In general, a cannabis employee who is offered equity compensation should understand the limitations that come with that offer. Marijuana is heavily regulated in states with licensing programs, and resale options for equity participation are limited by both securities law and various state regulations on marijuana company ownership. If a company is unwilling or unable to make large cash distributions to its owners, employee shareholders should realize that the value of their holdings may end up being worth nothing, and when that information will be unpredictable. .
Cannabis employees should treat the offer of equity compensation as they would any business decision. Research the company. Ask for relevant documents to help you in this search. Ask the owners and management team the tough questions and make your decision once you understand all the potential parameters.
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