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Incentive compensation (e.g., stock options, restricted stock, bonus plans, phantom stock, stock appreciation rights, etc.) can be a very useful tool for aligning the incentives of employees and shareholders, as well as a means of recruiting talent to early-stage companies who often lack sufficient cash to offer competitive salaries. Due to these factors, incentive compensation plans have become widespread and continue to be popular with companies of all sizes.

While popular and conceptually straightforward, a properly structured incentive compensation plan must comply with several areas of the law, including tax, securities, employment, employee benefits, contract and corporate laws. Reflecting these numerous underlying legal issues, the resulting plan document and grant agreements will tend to be fairly complex; however, well-crafted documents can (and should) be quite user-friendly.

However, as we have seen often in recent months, even a user-friendly set of documents can be undermined if the issuing company does not maintain a disciplined process when communicating grants, offers and other incentive compensation-related information to its employees and consultants. Consider the following scenarios, which are similar to fact patterns we have recently encountered in our practice:

Each of these scenarios resulted in what should have been easily avoidable difficulties. In Scenario 1, Company A put itself in a position of potentially breaching either its offer letter (by not granting the options at the promised exercise price) or its incentive compensation plan (by granting options with an exercise price that was less than 100% of fair market value). Similarly, in Scenario 2, the offer letter’s language was absolute, but Company B subsequently entered into a binding agreement with a third party that directly conflicted with its obligations under the offer letter. In Scenario 3, Company D’s imprecise internal communications created ambiguity regarding Employee C’s right to receive equity compensation (or lack thereof).

These are all thorny but easily avoidable problems if appropriate processes are implemented and followed by the issuing company. Below are some practical tips for avoiding these and similar scenarios when administering an incentive compensation plan:

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