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Young Ninja Group (ages 3-5)

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Small Business Stocks To Buy

Many smaller companies want to share ownership with employees but find the legal costs and complexities of various common plans daunting. For owners wanting to sell to employees, an employee stock ownership plan (ESOP) has great tax benefits, but its costs and complexities may be daunting. For other owners who just want to share some kind of equity interest with employees, stock options or restricted stock may be good choices, but other companies want something simpler still, or, if they are limited liability companies, do not have actual stock to share. So what kinds of strategies are available for these companies?

small business stocks to buy

Companies share ownership with employees for a variety of reasons. For some people, the reason may be simply "it's the right thing to do." For most others, however, there are purely practical reasons to share ownership. Employee ownership can have benefits for owners of businesses, employees, and their companies. Among these are:

The word "ownership" is used in different ways by different people. Legally, ownership of a business is a bundle of rights to reap the benefits of that business and to make decisions about how the business is run. The basic rights in a business are the right to company income, the right to the surplus value of the company if the company is sold, the right to make decisions about how the business should run, and the right to sell all or part of the value of the business.

The particular way in which the rights of ownership are assigned to owners in the company depends on its legal structure. A business must be set up in one of three ways: as a sole proprietorship, as a partnership, or as a corporation. In a sole proprietorship, business property, liability, and income are treated as the personal property of a single person. These businesses will have to first establish a partnership or incorporate to share ownership with employees.

Ownership can be shared directly with employees through partnerships or corporations, and also indirectly through tax-exempt benefit trusts. However, if the company meets certain qualifications, it can receive important tax benefits. Cooperatives, employee stock ownership plans, and profit sharing plans are the most common tax-benefited ownership structures in small businesses, although others exist. Each of these options is detailed below.

A partnership agreement can share decision making, profits, asset value, liability, and many other aspects and benefits of running a small business. A partnership can involve any number of partners, who may or may not be employees of the partnership. However, because of potential liability problems, such as the ability of a single partner to obligate the entire partnership to a contract, as well as the usual tax and liability advantages of incorporation, it is probably best to use partnerships to share ownership among only a small number of people. Partnerships will generally be the cheapest way to share ownership among less than five or six employees. Using self-help books, you can probably write a partnership agreement yourself and pay for legal counsel only to review the completed agreement.

Any incorporated business, no matter how small, can give or sell shares directly to employees. New shares can be created or they can be purchased from a previous owner. If employees acquire shares directly, they become direct owners, and can exercise all the rights associated with ownership, including a share of the company's equity value and voting rights. Employees can receive shares that give only voting rights, only equity rights, or both, and with any percentage of the total voting or equity stake. Employees can be allowed to resell their shares freely, or resale can be limited for any reasonable business purpose. If employees buy shares, the company must obtain an exemption from securities registration. Most private companies can obtain a so-called "Section 701 exemption" or another exemption from federal registration. However, an exemption from federal registration requirements does not always provide an exemption under state rules. Moreover, companies must still file anti-fraud disclosure statements to employees. This can cost several thousands of dollars on up.

Options do not provide employees with any control rights (unless the company creates these rights) until the shares are purchased, and even then the company can provide that only non-voting shares can be bought. The number of shares that will be in employee hands at any time because of the exercise of options is usually quite small as a percentage of total shares. Option plans are particularly popular with fast-growing companies that plan to be acquired or go public, but as long as companies can provide a market for the options, there is no technical or legal reason for a closely held company not to offer them.

For many smaller companies, these plans will be the most suitable because they are very simple. Phantom stock pays employees a cash bonus equal to a certain number of shares; SARs pay employees a cash bonus on the increase in the value of a certain number of shares. Employees are granted a certain number of phantom stock units or SARs, almost always with vesting requirements. They pay no tax at grant. When the awards vest, then employees do pay tax at ordinary income tax rates, while the company gets a deduction. In effect, phantom stock is the equivalent of restricted stock and SARs the equivalent of non-qualified options, except in that both typically pay out only at vesting and that there is no 83(b) election available for phantom shares.

Cooperatives are a type of company in which control is on a one person/one vote basis. Cooperatives can be set up as partnerships or corporations, and in some states, there are worker cooperative statutes. Whatever form a cooperative takes (most are set up as corporations), they qualify for special federal tax benefits. Cooperatives are the oldest form of employee ownership in the United States, dating from the early 1800s. Although they are not common in larger businesses, they make up a large portion of small employee-owned businesses.

Formal voting control must be on a one-person/one-vote basis. Usually most employees must be shareholders, although as many as half can sometimes be excluded. Generally, a cooperative cannot pay dividends, and must pay out any excess earnings not held in the company to employee shareholders based on salary, time worked, or some other work-related basis. However, if non-employee owners have a small percentage equity share and return on investment is limited, these owners can still be rewarded through dividends.

Persons who sell shares to a worker cooperative are exempt from capital gains taxes if the gain is reinvested in U.S. securities. Cooperatives are exempt from double taxation on dividends to employees that are based on time worked or salary rather than equity. Most small businesses will not need to pay out dividends anyway (see discussion in Financial Benefits in a Corporation), but this exemption gives cooperatives more flexible tax planning options than other corporations, letting them treat profits like either an "S" or a "C" corporation without changing their legal structure.

From the viewpoint of the company, it is advantageous if employees are willing and able to pay for shares (assuming securities registration can be avoided). It may be necessary for employees to put up money in order to complete a buyout, to convince lenders that employees will be committed to the employee-owned company, or because the company is not able to purchase or give away the shares. However, there has not been great success with employee ownership that relies on employees to put up their own money to buy shares. Lower and middle income employees have little extra income to spend on long-term savings of any kind, much less on risky investments in small companies. Employees can always refuse to buy or accept stock (unless it is a mandatory condition for employment). In most cases where ownership is for sale to employees rather than given as a benefit of employment and buying stock is not mandatory, only a few highly paid employees will participate, if any. Also, selling stock to employees who are not experienced investors may sometimes impose a legal obligation on the company to make sure that the employee is making a prudent investment, something that is not always easy to guarantee.

It is important to be clear on which approach you intend to take for your employee ownership. Formal voting control brings with it important legal rights. Most decisions are made on a day-to-day basis, not through formal corporate mechanisms. Experience has shown that employees are conservative shareholders, supporting recommendations made by management. But business owners should not give voting rights to employees with the expectation that they can retain all control for themselves. Whoever has voting control of the corporation has the right to choose and remove directors and corporate officers. If conflicts arise, these mechanisms may become important. Also, people often assume "ownership" includes control. If the desire is to create a mechanism by which employees can share in equity growth but not to control the company, then this should be clear to everyone involved from the beginning. Finally, the type of employee ownership structure chosen depends on which approach you will take. Not only must voting rights be structured differently, but different financial arrangements may be required according to who controls the company.

The "value" of a business is the value that it would sell for in a competitive market. This value is not always easy to determine. It reflects tangible things like assets, cash holdings, patents, property, and intangible things like goodwill, market conditions, and employee experience. But how do you actually get a number for this value? For a small company there are several practical approaches; it can use book value (the net value of assets over liabilities), use another formula, or hire a professional business appraiser (often costing $5,000 or more). ESOPs must get a formal valuation from an appraisser and have it updated annually. Although the cost is high, even when the plan is not an ESOP, a formal valuation is a good idea to prevent later legal disputes. 041b061a72


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