Public companies aren't the only ones offering stock options to employees.
Private companies have tempted talented employees with equity incentives for years, wooing them with the possibility of riches if the company has a successful initial public offering one day.
Now, a recent change by the Securities and Exchange Commission is making it easier for private companies to offer securities to their employees.
Forte Systems Inc. is an example. The 9-year-old West Chester, Pa., information-technology consulting company initiated a stock-options program for its 435 employees last year. The plan allowed employees to buy stock in Forte.
"It's been very successful," said Jeffrey Stello, Forte's chief financial officer. "If things keep going the way they are, it's highly probable that we will exceed the SEC's old issuing limit of $5-million."
With Forte considering going public in the future, that annual $5-million limit could have kept some employees from getting an equity stake in the company before the IPO. But that has changed since the SEC modified something known as Rule 701.
Under SEC guidelines, a private company determines the number of shares it is allowed to issue each year by the 15 percent rule: either 15 percent of its total assets or 15 percent of its outstanding securities each year. Whichever dollar value is higher sets the securities limit.
Previously, all private companies issuing securities to employees were subject to an absolute annual $5-million cap under Rule 701.
If they issued more than $5-million, companies would have had to file with the SEC the same documents as a public company would, a process that was burdensome and expensive for many smaller private companies. For larger companies, especially because the securities were used only for employee compensationand not to raise capital, the disclosure was considered intrusive.
Now, private companies are still subject to the 15 percent rule, but the $5-million ceiling has been removed.
The change, effective April 7, was designed to give private businesses more flexibility in issuing compensation to employees.
Between 1988 and 1993, the SEC estimated that an average of 214 private companies were selling stock to their employees annually. With the changes, the SEC anticipates an average of 300 private companies will sell stock to their employees annually.
"Now, as long as you meet the tests, the sky's the limit," said Alan Singer, a partner at the law firm of Morgan, Lewis & Bockius in Philadelphia. "Private companies can sell as many securities as they want."
An unlimited number of securities? It is much less risky than it sounds, Singer said.
"I don't think there's much danger," he said. "The most that can happen is that a company won't go public _ and the options will be worthless to the employees that own them."
Plus, the new guidelines come with a stipulation: Private companies issuing more than $5-million worth of securities a year are required to disclose plenty of company business to employees.
While public companies are required to file financial statements and other documents with the SEC, private companies generally operate outside such scrutiny.
Should a private company exceed that $5-million securities mark, it would be required to hand over a copy of the company compensation plan, terms of the investment, risk factors of investing in the company and a financial statement.
Those disclosures might keep a company from selling more securities than they should, Singer said.
"It's a mixed blessing," he said. "The real winners will be very small companies and very large companies."
Very small companies with few assets previously were limited to selling less than $500,000 worth of securities a year to avoid disclosure to the SEC, Singer said. Now, the smaller companies, including high-tech start-ups and family businesses, will be allowed to sell a minimum of $1-million worth of securities a year.
"Regardless of where it falls in the 15 percent test, a small company can always sell $1-million a year," Singer said. "That will be a real boon to companies just getting started, wishing to attract and retain talented people."
High-tech start-ups are particularly affected by this change, said Albert Dandridge, a partner at the law firm of Mesirov, Gelman, Jaffe, Cramer & Jamieson.
A lot of these companies do not have bricks and mortar or the other things we traditionally use to measure capital," he said.
Rather than measuring success by the number of buildings they have, Dandridge said, high-tech companies focus more on the talents of their employees.
"They have electrocapital, and they tend to reward employees with securities," said Dandridge, former associate director of the SEC's Division of Corporation Finance.
"It's a change in American entrepreneurialism, and it's important for the SEC to keep up with the marketplace."
Large private companies with many assets, on the other hand, will benefit from the removal of the $5-million ceiling.
"More and more employees are demanding equity in the places they work," Singer said. "It's probably one of the best employee benefits of the 1990s. In order to keep up, larger companies have to issue enough securities to make their businesses attractive places to work."
The SEC worked on the rule change for more than a year, said Richard Wulff, chief of the SEC's Office of Small Businesses.
"We solicited substantial comment and public input for this ruling. . . . We wanted to be sure that private companies, especially large private companies, had the opportunity to air their thoughts and concerns about it," he said.
Although responses were a "mixed bag" because of concerns about releasing company information to employees, Wulff said the rule change has been a smooth one.
"So far, we haven't heard about any problems," he said. "Hopefully, that means it's being used for the purpose it was designed."