How to offer stock options to independent contractors

Hiring independent contractors is a great way to leverage the knowledge and experience of subject matter experts, all across the globe.

And to attract the best contractor talent and build good relationships with them, stock options are an excellent incentive.

In this article, we’ll explain how you can offer stock options to your contractors safely and compliantly — wherever they are in the world.

Important: We use the terms "equity" and "stock options" interchangeably in this article. But it's important to note that, while both involve ownership stakes, they can come in different forms and structures (depending on the plan offered).

We’ll also cover the different types of stock plans, and clarify the difference between offering stock options to employees and contractors.

So let’s dive right in with the key question:

Can I offer stock options to contractors?

The short answer is yes. However, you have to ensure that your offering is compliant with all the relevant regulations in both your and your contractor’s country. In some regions, for instance, your contractor may be eligible to receive non-qualifying stock options, but your contractors in other countries may not.

The outline of the stock option agreement needs to be carefully worded, too. You should ensure that the plan enables your company to grant equity to non-employees, and also ensure that contractors are responsible for their own tax compliance. For example, employment can’t be a condition of exercising the options, which is often the case in many stock option programs.

Finally, it’s crucial to ensure that you don’t create misclassification risk — which can result in fines, penalties, and other restrictions. In many countries, providing any kind of benefit to your contractors can potentially lead to misclassification, so it’s important to understand the risks and how to mitigate them. We’ll discuss this in more detail further in the article.

When issuing stock options to contractors, continued engagement doesn’t always have to be a mandatory condition for receiving and exercising them. But, as mentioned, it can make a big difference in what type of options your contractor is eligible for. Each country has their own laws and regulations in this regard, so it’s recommended to review each contractor’s status on a case-by-case basis. 

What’s the difference between employee and contractor stock options?

In general, employee stock option schemes are more tax-friendly, especially when compared to the common types of options given to contractors. Usually, contractor stock option programs are structured in a similar way to employee options. However, you can structure a contractor option agreement to be exercisable on, say, the successful completion of a project, as opposed to being time-based. 

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How to offer stock options to foreign employees

Learn how to quickly, easily, and compliantly offer stock options to a global workforce with our detailed, expert-led guide.

Note that, in some cases, it may be more suitable — or even necessary — to convert your contractor into an employee.

When should you convert a contractor into an employee?

While contractor designations may be appropriate for some business relationships, companies can’t simply pay people as contractors just because it’s easier. Contractors and traditional employees fulfill different roles and have distinct legal definitions.

Converting a contractor to an employee can protect the employer from penalties, and provide a better experience for the contractor.

To learn more about when it's the right time to convert a contractor into an employee — and how to do so — check out our detailed guide.

What are the benefits of offering stock options to contractors?

Of course, before you start giving away part of your business, it’s worth understanding what’s in it for you. There are many reasons why a growing number of companies — especially fast-growing startups — are embracing stock options for contractors, such as: 

More capital

If you’re working on a shoestring budget, or bootstrapping your company with loans from friends, family, or savings, offering stock options is a great way to reduce your current capital requirements. It can also help improve your cash flow while still providing attractive packages for both your employees and your contractors. 

Increased contractor loyalty

One of the biggest plus points of hiring contractors is that it allows you to tap into a global talent pool and find the perfect person for your business. And once you’ve found them, you want to incentivise them and build stronger relationships — even if you don’t plan to hire them as an employee.

Offering stock options sends a clear signal to your contractor that you value their work and are willing to invest in their future. This, in turn, builds trust and generates long-term loyalty among your remote contractor workforce. 

An invested workforce

Recent research in China shows that participation in stock option programs leads to a more innovative environment which, in turn, can boost your company’s growth.

When your contractors know that they will benefit directly from your success — and share in your failures — they will be more invested and more determined to perform at a high standard.

A more equal and diverse workforce

By offering stock options to your team— no matter where they live in the world — you have an opportunity to make an impact on global wealth inequality, especially in retirement. It allows you to move away from mere good intentions and take meaningful actions to help otherwise marginalized workers build wealth. 

A stock option plan gives your contractor equity in your company regardless of their race, age, sexual orientation, ethnicity, or country of origin. And your business will benefit from a more diverse set of ideas, opinions, and backgrounds — which is proven to boost company performance. 

An incentive to attract key advisers and consultants

Early-stage businesses often operate at a distinct disadvantage — they can’t afford the kind of bespoke advice that could otherwise help them grow and scale. The kinds of fees charged by large consulting firms can be steep, causing many founders to make difficult financial choices or eliminate the option of advice altogether.

As subject matter experts, many contractors are well-placed to act as consultants. Stock options are an attractive way to entice them when you need guidance — and your budget is tight.

What are some of the disadvantages of offering equity or stock options to contractors?

It’s important to know the disadvantages of offering equity or stock options to contractors. These can include: 

Potential conflicts of interest

One of the primary risks when offering equity to contractors is possible conflicts of interest. 

Contractors might prioritize short-term stock gains over the long-term health and goals of the company. They could divert strategies or influence decisions in a way that benefits them personally. 

For example, they might focus more on projects that are relevant to stock prices and less on those that aren’t. 

Dilution of control

Offering stock options to contractors can also give you less control over the business. 

Each share awarded to a contractor reduces how much the existing stakeholders own in the company. That can alter the decision-making dynamics within the company and complicate future investment negotiations. 

Investors may also be hesitant to invest in a company with significant ownership among non-employees.

Compliance and misclassification risks

When you offer equity to contractors, the legal complexities increase. 

Stock option agreements must be carefully drafted. It has to be clear that the contractor isn’t viewed as an employee. This often requires additional clauses and precise wording. As mentioned, misclassification can lead to legal penalties, back-payment of benefits, and other tax liabilities.

Increased administrative burden

Lastly, administering equity plans for contractors introduces a sizable administrative burden. It requires the company to manage detailed records, stay compliant with multiple jurisdictions' regulations, and make regular updates to legal documents. This can strain its resources and divert attention from its core business activities.

What type of equity incentives can you offer to contractors? 

Stock options and other equity incentives come in different flavors, and not all of them may be suitable for your contractors. It’s worth taking a few minutes to understand the key differences between some of the most popular types. 

Non-qualified stock options (NSOs)

If you’re using an employer of record (EOR), NSOs allow your foreign contractors to legally receive equity in your business. That’s in the same way your domestic contractors and employees do. NSOs are available to anyone providing services to your company, including advisers and contractors. 

Restricted stock units (RSUs)

An RSU is a conditional stock option that’s awarded when certain events occur. A “single trigger” RSU has one condition (such as a predetermined performance milestone), while a “double trigger” RSU has a second condition, like an IPO. 

Note that RSUs can come with potential tax implications. In the US, for instance, taxation applies to the full market value of RSUs when they vest. If the contractor doesn’t sell the RSUs as soon as they vest, there will be later taxes on any capital gains. That could be either under short-term capital gain rules (if held for less than a year) or long-term capital gain rules (if held for over a year).

RSUs can be complex, so it’s recommended to work with a global HR specialist to plan out your equity incentives. Or, you can hire stock options consultants for advice. 

Virtual stock options (VSOs)

VSOs are better defined as cash bonuses that are tied to the price of your stock. It’s a way for you to reward your contractors without granting equity in your company.

As they are tied to your company’s performance, VSOs are a great way to incentivize your contractors. However, because they’re paid in cash, they’re always subject to income taxation. The tax rate can vary depending on what country your contractors work in, with some countries considering VSOs to be straight income and others considering it a fringe benefit. VSOs are especially common in European countries.

What are the key considerations when offering stock options or equity to contractors?

When offering equity to a contractor, it's essential to understand how it’ll work for both them and your company. Here are some key considerations to make:

1. The right fit and amount

Decide if stock options are the optimal incentive. Think about whether it might be easier to provide a financial bonus instead. 

You also need to clarify whether you can offer stock options in your contractor’s country.

If stock options are a good choice, the amount you offer should reflect the contractor’s role and contributions to the company. Of course, make sure the amount is financially sustainable for the business, too. 

2. Structuring the options

Choose how the stock options will be set up. 

You can have them vest over a period of time, which encourages long-term involvement. Or they can be based on achieving specific project milestones, which shifts the contractor’s focus to immediate goals.

3. Clear agreements

The terms in the stock option agreement should be clear and detailed. 

Include how and when the options can be exercised and what happens if the contractor leaves. Clarity here helps prevent future misunderstandings and potential legal issues.

4. Legal compliance

Make sure your offer aligns with the stock option laws in the contractor’s country. This involves understanding the rules and regulations about how these incentives should be handled. 

Partners like HR platforms or freelance stock options consultants can be invaluable here.

While the securities industry is global, it’s mostly regulated nationally. Each jurisdiction has different requirements for how securities are handled. For instance:

• Some regulatory bodies, like the US Securities and Exchange Commission (SEC), apply local requirements in nearly all circumstances

• Some bodies exempt foreign financial intermediaries from certain requirements

• Some bodies fully exempt foreign intermediaries from many (or all) local requirements

5. Educating contractors

Ensure that each contractor understands what receiving stock options or equity means. They should especially know the tax implications and how their work impacts the value of these options. 

Well-informed contractors are more likely to value the offer of equity and to contribute to your company's success.

Potential issues when providing stock options or equity  to contractors

Unfortunately, there have also been cases where stock options have inadvertently become a problem for foreign contractors, resulting in issues like double taxation. 

The OECD, which stands for Organisation for Economic Co-operation and Development, lists some of the issues related to cross-border income taxes, including:

• Timing mismatch in taxing benefits

• Distinguishing income from capital gains Organisation for Economic Co-operation and Development, lists some of the issues

• Difficulty in determining which service or contract the stock option belongs to

• Services being provided in more than one country

• Taxes owed to multiple countries due to multiple residencies of the contractor

• Compliance issues like tax withholding

• Merger and acquisitions, or an IPO, disrupting the original stock option agreement

It’s essential for you and your contractors to obtain the right localized tax advice to make sure there are no unwelcome tax obligations. Remote’s local, on-the-ground contractor management specialists can help you better understand the implications of offering equity incentives to your contractors, and advise on the best type of plan.

How can Remote help?

Administering any kind of stock option plan can be confusing, but especially so when the recipients are globally-dispersed contractors. This is why it’s advisable to work with a global HR partner, like Remote.

Remote makes it easy to manage your contractors, wherever they’re based. And through our tax, legal, payroll, and benefits experts, we can help you identify the best equity incentive plan for your contractors while keeping you compliant with the relevant tax and reporting requirements.

Specifically, we can help you:

• Select the right equity incentive for your contractors

• Determine the stock option plan most beneficial to your organization

• Manage any tax reporting obligations

• Follow local labor laws

• Meet any regulatory requirements for offering stock options to contractors

• Create a culture that’s attractive to contractors with the skills you need to grow and scale your business   

Offering a stock option plan to your global contractors

Developing a solid stock option plan for your contractors requires knowledge of securities laws, taxation regulations, and employment classifications — and each of these factors differ by country. The time you spend on addressing these problems can take you and your team away from the other areas of your day-to-day operations, and distract you from what you really want to be doing: growing your business.  

On the flipside, keeping your top contractor talent happy and motivated is a competitive advantage. Giving them equity in your business shows a high level of trust, and is a massive perk not often available to contractors.

Manage contractors with Remote

Offering stock options to contractors is a powerful strategy for attracting and keeping top talent globally. By understanding the different types of stock plans and the legal considerations in various countries, you can implement these incentives.

To learn more about how we can help you offer stock options and equity incentives to your contractors, speak to one of our friendly experts today.

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