Equity Incentives: A Way to Grow Your Healthcare IT Company

October 15, 2020

If you’re involved in a Healthcare IT startup, you’ve likely lost more than a night’s sleep worrying about your technology’s ability to protect patient data and privacy against a growing number of cybersecurity threats while also demonstrating compliance with HIPAA and other relevant standards. Top-tier HIPAA compliance and risk management can be costly. It’s also impossible to achieve without the right team of top talent.

How can you balance paying the compensation that will attract the best talent while also managing all the other security, compliance, and development costs?

One option that tech startups have relied on for years is equity incentives. However, there are many different types of equity incentives to choose from, so it is important to understand the alternatives available and the various pros and cons of each.

Choosing the Right Equity Incentives to Offer

There are 4 primary types of equity incentives your Healthcare IT company should consider.

  1. Stock Options

Stock options are a tried-and-true way to attract new talent whether cash flow is tight or not. There are two primary types of stock options, including Incentive Stock Options (ISOs) and Non-qualified Stock Options (NSOs). At the most basic level, ISOs receive beneficial tax treatment for recipients because there is no income tax due upon exercise, while the exercise of an NSO will usually trigger an income tax obligation upon exercise.

You can read our more in-depth article on these options, or you can work with an Aprio tax advisor to understand the tax implications of each and determine which is best for your Healthcare IT company.

  1. Restricted Stock Grant

Restricted stock Grants are simply a stock issuance subject to certain defined restrictions, such as vesting and forfeiture. Startups often turn to restricted stock when hiring C-Suite executives as a way to give them immediate “skin in the game” while protecting the company if the relationship doesn’t go well.

If your Healthcare IT company is trying to take your risk management and compliance to the next level, you’re probably looking to hire a CTO, CISO, or CIO soon. Creating the best product requires hiring the best team, but it can be tough to balance the costs. Consider offering restricted stock as a way to enhance the compensation package without undercutting the funds for advancing your technology. Just make sure you are aware of the tax issues associated with these grants. Check out our article that answers 7 of the most common questions on restricted stock.

  1. Profits Interests in entities taxed as Partnerships, such as LLC’s

Because of the flexibility that LLCs offer, many Healthcare IT companies are choosing an LLC as their entity structure of choice. However, entities taxed as partnerships, such as LLCs, cannot award stock options. Nonetheless, there is still a valuable equity incentive you can provide to attract and retain key employees of LLC’s, which is often referred to as profits interests.

Profits interests can offer some of the same favorable tax treatments as a restricted stock grant and, as such, provide for actual current ownership interest. While a restricted stock grant usually results in an income tax obligation upon issuance, an LLC Profits Interest can be done with no current tax obligation.  Like other equity incentives, profits interests provide a valuable tool that your Healthcare IT company can use to make growing your team and enhancing your product a reality.  Aprio can help you and your company structure a profits interest plan that meets your needs to retain and attract key people to your Healthcare IT company.

  1. Section 1202

Section 1202 is an often-overlooked provision of the Internal Revenue Code that provides an exclusion from income tax on up to $10M of gain from the sale of qualifying stock. The benefit is available to those who invest in emerging and small businesses that are structured as regular Corporations for income tax purposes, a category that many Healthcare IT companies fall under (especially at the startup phase). Understanding and leveraging the benefits offered by Section 1202 can be critical in attracting new talent and investors because it further incentivizes any stock your company provides.

Matching this benefit with alternatives 1, 2, and 3 above can yield even greater benefits for each employee.  Aprio can help you understand how this will impact investors and employees who receive stock options or grants of stock. You can read our more thorough article to understand the exact qualifications, benefits, and requirements of Section 1202, or you can reach out to an Aprio advisor to investigate how Section 1202 can provide an added incentive as you seek to expand your team.

The Bottom Line

Advancing your Healthcare IT company’s security and compliance requires a team of the highest caliber who can set and achieve your goals for risk management, and attracting the right people for the job requires a competitive compensation package. That can feel daunting when the costs of security and compliance are always rising. Think of equity incentives as a creative way to attract and retain top talent while still prioritizing investment in your product.

This article provides only a brief understanding of equity incentives. We recognize that implementing an equity incentive plan is extremely complex, so it’s best to work with a knowledgeable advisor to determine what is best for your company. Aprio can help you with valuable tax planning related to these alternatives, including helping you maximize your position and navigate the reporting requirements.

Reach out to Ori Epstein for more information.

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About the Author

Ori Epstein

Ori's practice focuses on the technology sector, including software, biosciences and healthcare IT companies at all stages of their life cycles. In his 12 years at Aprio, he has assisted with numerous complicated issues and transactions, including navigating the medical device excise tax, tax-free spinoffs and reorganizations, and international tax planning.