California Bill Aims to Limit Cookie Privacy Lawsuits

California Bill Aims to Limit Cookie Privacy Lawsuits

Varnum Viewpoints

  • Expect continued litigation risk in the near term. CIPA lawsuits targeting website cookies are widespread, with over 1,500 filed in the past 18 months.

  • Relief is on the horizon, but delayed. Senate Bill 690 would create a “commercial business purpose” exception, protecting routine business uses of cookies, but it won’t take effect until January 2026 and won’t apply retroactively.

  • Proactive steps are critical. Regardless of whether SB 690 is ultimately passed, businesses should be prepared for an increase in demand letters and lawsuits and should consult counsel to assess risk and develop response strategies.

Companies that use cookies on their websites have seen a flood of lawsuits and demand letters claiming the industry-standard software violates users’ privacy rights by collecting personal information.

Many of these claimants rely on theories of liability under California law, which they argue applies even if the company does not have a physical presence in the state. The claimant’s goal is often to extract a nuisance-value settlement, then move on to the next target. The California Invasion of Privacy Act (CIPA) is a particularly attractive statute for cookie litigants because it provides for statutory damages of $5,000 per violation.  

California lawmakers have taken notice of these CIPA-related “shakedown letters and lawsuits” observing that “[i]n the last 18 months, trial lawyers have sued over 1,500 business using [CIPA]’s private right of action, arguing that these typical business activities constitute ‘wiretapping’ or an illegal ‘pen register,’ necessitating ‘opt-in’ consent before the business can, for example, save an online shopping cart or show an ad.”

See Senate Committee on Public Safety Bill Analysis, Senate Bill 690, 2025-2026 Reg. Sess. (April 25, 2025). 

Legislative Response: Senate Bill 690

To combat these lawsuits, the California State Senate unanimously passed Senate Bill 690, which would substantially reform CIPA by creating a “commercial business purpose” exception. Specifically, SB 690 would:

  1. Exempt commercial business purposes from the general prohibition against eavesdropping or recording a confidential communication.
  2. Clarify that the civil action authorized under current law for a person injured by a CIPA violation does not apply to the processing of personal information for a commercial business purpose.
  3. Specify that a trap and trace device, as defined in the CIPA, does not include a device or process used in a manner consistent with a commercial business purpose.
  4. Specify that a pen register does not include a device or process used in a manner consistent with a commercial business purpose.
  5. Define “commercial business purpose” as the processing of personal information either to further a business purpose, as defined in the California Privacy Act, or subject to a consumer’s opt-out rights.

SB 690 is now in the California State Assembly. If passed, it will go to Governor Gavin Newsom for final approval. Based on bipartisan support, the bill appears poised for enactment in 2026.  

Implications for Businesses

While SB 690 would be a welcome change for businesses that have received CIPA-related demands, there is an important caveat: the bill would not apply retroactively and would not take effect until January 2026.

Regardless of whether SB 690 is ultimately enacted, its delayed effective date may prompt a new wave of cookie-based CIPA lawsuits in the months ahead, as claimants seek to file before the commercial-purpose exception becomes law.

Varnum is experienced in handling CIPA and online privacy litigation. If you receive a CIPA demand letter or lawsuit, contact your Varnum attorney, Varnum’s Data Privacy Practice Team, or Varnum’s Litigation Practice Team.

Summer Associate Alex Sax contributed to this advisory. Alex is currently a law student at Wayne State University Law School.

Florida Passes Major Reforms for Community Associations

Florida Passes Major Reforms for Community Associations

Update August 21, 2025: A provision added to Chapters 718 and 719, Florida Statutes, now requires all condominium and cooperative associations to create and maintain an online account with the DBPR on or before October 1, 2025. Associations will use this account to provide governance, building, and financial information as part of the state’s broader transparency and compliance initiative. Create an online account.

Florida’s most recent legislative session introduced a series of changes impacting condominium and cooperative associations aimed at increasing transparency, accountability, and safety.

Stricter Licensing Rules for Community Association Managers

Community association managers (CAMs) are now required to maintain an active license with the Department of Business and Professional Regulation (DBPR), which includes keeping their information up to date regarding the associations and firms they represent.

If a CAM’s license is revoked, they are prohibited from owning or working for a management firm for a period of ten years. Associations must verify that their CAMs are appropriately licensed and in good standing, marking a notable shift in compliance duties at the board level.

Expanded Building Safety and Reserve Oversight

The legislation reinforces requirements for milestone inspections and structural integrity reserve studies (SIRS). Associations must complete their first SIRS by December 31, 2025, and include a funding plan to support long-term structural needs.

Boards may pause or redirect reserve contributions in specific emergencies or inspections, but only with membership approval and in accordance with new statutory procedures. Board members must also sign an affidavit acknowledging receipt of completed SIRS, reinforcing their fiduciary responsibility.

New Standards for Meetings and Records

Operational procedures have also been modernized. Boards may now meet by video conference, but must follow new rules regarding meeting notice, access, recording, and retention of materials. Video recordings must be preserved as official records for a minimum of 12 months.

Additional changes to accounting and insurance appraisal requirements aim to ensure associations are appropriately documented and insured. By October 1, 2025, associations must also maintain an online account with the DBPR containing essential building, governance, and financial information.

Reserve Funding and Investment Options

The threshold for capital repairs requiring funding has increased from $10,000 to $25,000, with future adjustments tied to inflation. For items identified through a SIRS, funding must follow a baseline plan that ensures long-term adequacy.

Funding can be obtained through assessments, loans, or lines of credit, subject to member approval. Boards now have greater flexibility to invest reserve funds in insured financial institutions without a membership vote, provided that investments are made with sound judgment.

These updates aim to give boards stronger financial tools and greater responsibility in safeguarding the association’s long-term stability.

For questions about how these changes may impact your community or to ensure your association is fully compliant, contact Varnum’s Condominium and Homeowners Association Practice Team.

2025 summer associate Nolan Thomas contributed to this advisory. Nolan is currently a law student at the University of Miami.

This advisory was originally published on June 27, 2025, and updated on August 21, 2025.

How New Tax Legislation Impacts Clean Energy Tax Credits

How New Tax Legislation Impacts Clean Energy Tax Credits

On August 15, 2025, the Treasury Department released new guidance clarifying when a solar or wind project is deemed “under construction” for purposes of federal clean-energy tax credits. Under the prior rules, a project could satisfy the requirement by either (i) initiating physical work of a significant nature or (ii) incurring at least 5% of the total project costs and there is continuous work on the project. The new guidance removes the 5% safe harbor and provides that a project will only be considered under construction when “physical work of a significant nature” has commenced. Qualifying work may occur on-site or off-site, depending on the specific circumstances of the project.

On Friday, July 4, President Trump signed into law the budget reconciliation bill H.R. 1. (the Act), formerly known as or nicknamed the “One Big Beautiful Bill Act”. Among other substantial changes to the tax code, the Act significantly reduces tax incentives for clean energy practices, terminating many of the environmental and clean energy tax credits introduced by the Inflation Reduction Act (IRA) of 2022. Many of those credits were scheduled to remain in effect until 2032.

The Act impacts clean energy tax credits in two key ways:

  1. It accelerates the expiration and phasing out of certain credits.
  2. It prohibits specified foreign entities, foreign-influenced entities, and domestic entities that receive material assistance from specified foreign entities from claiming certain credits.

Credit Phase-Outs

Taxpayers currently engaged in clean energy projects should be aware of critical deadlines to begin construction or place projects in service to remain eligible for tax credits.

For example, solar and wind facilities must either:

  • Begin construction within one year of the Act’s enactment (i.e., before July 4, 2026), qualifying for a four-year continuity safe harbor; or

  • Be placed in service by December 31, 2027, to remain eligible for the Clean Electricity Production or Clean Electricity Investment credits before those credits are phased out.

These new deadlines do not apply to energy storage technologies, including those placed in service at wind or solar facilities, or certain other qualified technologies.

The Act also introduces a tiered adjustment for the domestic content bonus threshold under the Investment Tax Credit (ITC), similar to the structure used for the Production Tax Credit (PTC).

Foreign Entity Restrictions

In addition to timing changes, the Act imposes new limitations on foreign involvement in clean energy projects.

Many tax credits are now unavailable to “specified foreign entities” and “foreign-influenced entities.” Specified foreign entities include:

  • Chinese military companies

  • Entities of concern identified under the William M. Thornberry National Defense Authorization Act

  • Entities listed in Public Law 117-78

  • Entities specified under Section 154(b) of the National Defense Authorization Act

  • Foreign-controlled entities.

A foreign-influenced entity includes an entity under the direct authority of, or partially owned by, a specified foreign entity.

Summary of Key Energy Tax Credit Changes

Clean Vehicle Credits:

  • Previously-Owned Clean Vehicle Credit (25E), Clean Vehicle Credit (30D), and Qualified Commercial Clean Vehicles Credit (45W) expire for vehicles acquired after September 30, 2025, previously scheduled to expire on December 31, 2032.

  • Alternative Fuel Vehicle Refueling Property Credit (30C) expires on June 30, 2026, previously scheduled to expire on December 31, 2032.

Home Improvement Credits:

  • Energy Efficient Home Improvement Credit (25C) expires for property placed in service on or after December 31, 2025, previously scheduled to expire on December 31, 2032.

  • Residential Clean Energy Credit (25D) expires for expenditures made after December 31, 2025, previously scheduled to expire on December 31, 2034.

  • New Energy Efficient Home Credit (45L) expires for homes acquired after June 30, 2026, previously scheduled to expire on December 31, 2032.

Electricity Credits:

  • Clean Electricity Production Credit (45Y) phases out beginning in 2032, previously scheduled to phase out later in 2032 or the year in which greenhouse gas emissions from electricity production were reduced to a specified level.

  • Clean Electricity Investment Credit (48E) prohibits facilities from receiving material assistance from prohibited foreign entities if construction begins after December 31, 2025.

  • Wind and solar facilities must begin construction by July 4, 2026, or be placed in service by December 31, 2027, to remain eligible.

  • Clean Electricity Production Credit and Clean Electricity Investment Credit are unavailable to specified foreign entities and foreign-influenced entities.

Nuclear and Hydrogen Credits:

  • Zero Emission Nuclear Power Production Credit (45U) is unavailable to specified foreign entities; eligibility ends for foreign-influenced entities two years after enactment.

  • Clean Hydrogen Production Credit (45V) expires for facilities with construction beginning on or after January 1, 2028, previously scheduled to expire on January 1, 2033.

Manufacturing Credits:

  • Advanced Manufacturing Production Credit (45X) phases out beginning with critical minerals produced after December 31, 2030. Production of metallurgical coal produced after December 31, 2029, and production of wind energy components produced and sold after December 31, 2027, are not eligible for the credit.

  • The credit is unavailable to specified foreign entities and foreign-influenced entities. Eligible components used in a product sold before January 1, 2030, cannot receive material assistance from prohibited foreign entities.

Clean Fuel Credits:

  • Clean Fuel Production Credit (45Z) is extended to fuel sold on or before December 31, 2029, previously scheduled to expire on December 31, 2027. The credit is unavailable for fuel derived from feedstock sourced outside the U.S., Mexico, or Canada starting December 31, 2025. It is also unavailable to foreign entities on that date and two years after enactment for foreign-influenced entities.

Carbon Capture Credits:

  • Carbon Oxide Sequestration Credit (45Q) is unavailable to prohibited foreign entities and foreign-influenced entities.

On July 7, 2025, President Trump issued an Executive Order requiring the Treasury and Interior Departments to strengthen provisions in the Act that eliminate tax credits for solar and wind energy projects. Specifically, the order requires the Treasury Department to “issue new and revised guidance… to ensure that policies concerning the ‘beginning of construction’ are not circumvented.” Moving forward, developers should carefully document construction start dates on solar and wind projects to ensure eligibility for ITC and PTC tax credits. Varnum attorneys will continue to monitor developments and provide updates as additional Treasury guidance becomes available.

Individuals and businesses involved in or considering clean energy projects should consult with an attorney in Varnum’s Environmental and Renewable Energy practice to ensure current projects meet the new deadlines and eligibility for tax credits. Taxpayers operating within affected industries, particularly wind and solar, should consult with one of our attorneys to understand the full implications of the Act.

2025 summer associate Julia Sommerfeld contributed to this advisory. Julia is currently a law student at Ohio State University Law School.

This advisory was originally published on July 11, 2025, and updated on August 20, 2025.

Independent Contractor Rules in Flux: What Employers Need to Know

Independent Contractor Rules in Flux: What Employers Need to Know

A constant challenge for many employers is whether all workers must be treated as employees, or whether some may be treated as independent contractors. Workers who qualify as independent contractors are not subject to many of the employment laws that apply to employees, such as wage and hour laws requiring overtime pay. They also are not subject to tax withholding and typically receive a 1099 instead of a W-2. 

The rules governing who is, and who is not, an independent contractor are frequently changing. Employers must tread carefully when deciding to classify a worker as an independent contractor.

Department of Labor Abandons 2024 Rule for Classifying Workers 

In 2024, the U.S. Department of Labor (DOL) under the Biden Administration issued a final rule that redefined which workers should be classified as “employees” and which workers qualify as “independent contractors” under the Fair Labor Standards Act (FLSA), the federal law that mandates the payment of minimum wage and overtime. 

However, in a field assistance bulletin issued on May 1, 2025, the DOL’s Wage and Hour Division, under the new Trump Administration, announced it will no longer apply the 2024 rule. Instead, the division will rely on the independent contractor standard established in 2008.

Under the FLSA, employees are entitled to minimum wage and overtime pay for any hours worked over 40 in a workweek, unless exempt. Independent contractors, by comparison, typically have more autonomy, including the opportunity to work for multiple companies, set their own schedules, and negotiate terms and compensation.

Whether a worker qualifies as an “independent contractor” or must be classified as an “employee” has been a contentious legal issue. The 2025 shift reverts to the 2008 standard, which directs courts to consider the following seven factors:  

  1. The extent to which the services are integral to the business.
  2. The permanency of the relationship.
  3. The worker’s investment in facilities and equipment.
  4. The degree of control by the principal.
  5. The worker’s opportunities for profit and loss.
  6. The amount of initiative, judgment, or foresight required.
  7. The degree of independent business organization and operation.

This return to the 2008 standard is expected to make it easier for workers to qualify as independent contractors than under the 2024 final rule.

Notably, while the DOL will no longer apply the 2024 rule in its enforcement actions, it has not formally rescinded the rule. As a result, the rule remains in effect for private litigation, meaning employers should remain cautious in their classification decisions.

Michigan Senate Proposes ABC Test for Classifying Workers

Employers should take note that the DOL’s new independent contractor test, which returns to the 2008 test, applies solely under the FLSA. Many states, including California and New Jersey, use more stringent standards for worker classification under their own wage and hour laws.

In Michigan, the Senate has introduced legislation that would change how employers classify workers. Senate Bill 6 (SB 6) seeks to adopt California’s “ABC test” for determining independent contractor status. Under the ABC test, a worker must meet all three criteria to be considered an independent contractor:

  1. “The individual is free from control and direction of the payer in connection with the performance of the work, both under contract and in fact.”
  2. “The individual performs work that is outside the usual course of the payer’s business.”
  3. “The individual is customarily engaged in an independently established trade, occupation or business of the same work performed by the individual for the payer.”

The ABC test presents a higher standard than Michigan’s current 20-factor test. When California enacted a similar ABC law, it later amended the legislation to exclude numerous professions and industries. As of now, no similar exceptions are included in SB 6.

In addition to changing the classification criteria, SB 6 proposes severe penalties for misclassification, including possible imprisonment and substantial fines. The bill has not advanced in the Michigan Senate and currently remains stalled.  

Employers should also be aware that the IRS has its own test for independent contractor status. While similar to those used by the DOL and states, it is not identical. The IRS test determines whether a worker should be classified for tax purposes as an independent contractor, eligible for a 1099, or as an employee, subject to withholding and issued a W-2.

Varnum will continue to monitor developments surrounding Michigan SB 6 and the evolving federal independent contractor rules. Please contact your Varnum attorney or any member of our Labor and Employment Practice Team with questions regarding worker classification.

New Executive Order Targets NIL and College Sports Reform

New Executive Order Targets NIL and College Sports Reform

On July 24, 2025, President Trump issued an executive order aimed at addressing recent legal developments that have changed traditional college sports structures, particularly regarding athlete compensation, transfer rules, and the proliferation of state-level name, image, and likeness (NIL) laws.

The executive order includes six key policy directives:

1. Protection and Expansion of Women’s and Non-Revenue Sports

  • Athletic departments with more than $125 million in revenue are directed to increase scholarship opportunities and maximize roster spots in non-revenue sports compared to the 2024-2025 season.
  • Athletic departments with revenues between $50 million and $125 million must maintain at least the same level of scholarship opportunities and roster spots in non-revenue sports as the previous year.
  • Athletic departments with revenue below $50 million, or without revenue-generating sports, are instructed not to disproportionately reduce opportunities based on a sport’s revenue.

2. Prohibition of Third-Party Pay-for-Play Payments

  • The order states that third-party pay-for-play payments to collegiate athletes are improper and should not be permitted by universities. However, it allows for fair market value compensation for legitimate endorsements and services.

3. Federal Agency Action and Regulatory Enforcement

  • The Secretary of Education, in consultation with other federal agencies, is tasked with developing a plan within 30 days to advance these policies through regulatory, enforcement, and litigation mechanisms. This may include leveraging federal funding, enforcing Title IX, and addressing unconstitutional state actions affecting interstate commerce.

4. Clarification of Student-Athlete Status

  • The Secretary of Labor and the National Labor Relations Board are directed to clarify the employment status of collegiate athletes, with the goal of maximizing educational benefits and opportunities.

5. Legal Protections for College Athletics

  • The Attorney General and the Federal Trade Commission are instructed to review and revise litigation positions and policies to help preserve the long-term availability of collegiate athletic scholarships and participation opportunities, particularly when challenged under antitrust or other legal frameworks.

6. Support for U.S. Olympic Development

  • The order calls for consultation with the United States Olympic and Paralympic Committee to safeguard the role of collegiate athletics in developing athletes for international competition.

Impact and Outlook

It remains unclear how much practical change the executive order will bring to college athletics since it does not create enforceable rights for private parties. Key terms such as “fair market value” or “student-athlete status” remain undefined. Many open questions are likely to be addressed through subsequent agency action.  

Interested parties should monitor developments across federal agencies in response to the executive order. However, lasting changes to the college sports regulatory landscape will likely require congressional legislation.

The college athletics environment continues to evolve rapidly. For questions or guidance, contact Varnum’s NIL Practice Team to ensure compliance with applicable rules and regulations.

Legal Documents Your Child Needs When They Turn 18

Legal Documents Your Child Needs When They Turn 18

When a child turns 18, they’re legally considered an adult, which means parents no longer have automatic access to their medical information. Even if a parent or guardian has been managing their child’s health care for years, privacy laws like HIPAA (Health Insurance Portability and Accountability Act) prevent providers from sharing details without the child’s consent.

Without the proper legal documents in place, parents may find themselves unable to access crucial medical information or make decisions during an emergency. To avoid this, it is essential for young adult children to complete a few key forms as soon as possible after they turn 18, including a Patient Advocate Designation, HIPAA Medical Authorization, and Financial Power of Attorney.

Why Are These Legal Documents Critical for Adult Children?

1. Patient Advocate Designation and Living Will

This legal document appoints someone, often a parent, to make medical decisions on behalf of the child if they’re unable to do so themselves, such as during a medical emergency. The living will section allows the individual to express their preferences regarding end-of-life care, alleviating uncertainty and emotional burden for family members during difficult times.

2. HIPAA Medical Authorization

This authorization allows healthcare providers to share the child’s medical information with you, the parent, without violating privacy laws. Often combined with the Patient Advocate Designation, it ensures that you have the necessary information to make informed medical decisions.

3. Financial Power of Attorney

This document authorizes you to manage your child’s affairs, including paying bills and managing student loans, in the event they become incapacitated.

Consequences of Not Having Important Planning Documents

Without a Patient Advocate Designation, HIPAA Medical Authorization, and Financial Power of Attorney, parents must petition the probate court to become a legal guardian or conservator. This process is often costly, time-consuming, and can delay critical medical or financial decisions during emergencies.

Protecting Your Young Adult Child

Whether your child is preparing to leave for college or turning 18 at home, now is the time to implement these essential legal protections. Proper planning safeguards your child’s interests and prevents unnecessary legal complications for your family.

For additional information or assistance with patient advocate designations, HIPAA authorizations, and power of attorney documents, please contact your Varnum attorney or a member of our Estate Planning Practice Team.

This advisory was originally published on August 27, 2019, and republished on August 29, 2022. 

Understanding Surrogacy Compensation Under Michigan’s New Law

Understanding Surrogacy Compensation Under Michigan’s New Law

On April 2, 2025, the Assisted Reproduction and Surrogacy Parentage Act (ARSPA) went into effect, making Michigan the final state to lift its criminal ban on compensated surrogacy. This landmark law allows intended parents and surrogates to enter legally enforceable agreements that include compensation, free from criminal penalties. It also establishes a clear process for securing judgments of parentage, aligning Michigan with modern family-building practices across the United States. This advisory provides an overview of the typical compensation practices and related financial considerations found in Michigan surrogacy agreements under the new law.

Base Compensation

One of the key elements in a surrogacy agreement is base compensation, which is negotiated between the parties and paid to the surrogate for her time, commitment, and willingness to undertake the medical and emotional responsibilities of pregnancy. This typically begins after a pregnancy is confirmed by ultrasound and continues monthly until delivery.

In most agreements, a portion of the base compensation becomes fully vested after a specific stage of pregnancy, ensuring fairness in the event of a loss or premature delivery. The amount varies and is influenced by factors such as prior surrogacy experience, region, and whether an agency is involved.

Reimbursable Expenses

In addition to base compensation, most agreements reimburse surrogates for out-of-pocket expenses. Michigan law requires reimbursement only for the surrogate’s independent legal counsel. However, it is common for intended parents to also cover a range of pregnancy-related costs, consistent with established surrogacy practices and the goal of minimizing the surrogate’s financial burden.

Typical reimbursements include health insurance premiums and accidental death coverage, often secured by the intended parents. Many agreements also include monthly allowances for expenses, including transportation, over-the-counter medications, and pregnancy supplies. Maternity clothing and travel for medical appointments, especially over long distances, are also usually covered. If a physician orders bed rest or other restrictions, agreements often include additional support for childcare or housekeeping.

Medical Procedures or Complications

Most agreements include compensation for certain medical events or procedures. This can cover cesarean delivery, selective reduction, surgical procedures related to miscarriage, and other complications. If long-term consequences arise, such as loss of reproductive organs, additional compensation may be provided.

Escrow and Payment Management

While the law does not require escrow, using a licensed escrow agent is widely considered best practice. Escrow ensures payments are timely, documented, and managed to protect all parties.

Typically, intended parents deposit funds at the outset, and the escrow agent disburses them based on a written schedule. Most agreements require maintaining a minimum balance throughout the pregnancy and shortly after delivery.

Tax Considerations

Surrogates should be aware of potential tax implications. Although the Internal Revenue Service (IRS) has not issued formal guidance, compensation is generally presumed to be taxable. The taxability of payments may depend on their nature and how they are structured. Both surrogates and intended parents are encouraged to consult with qualified tax professionals.

Final Considerations

In conclusion, Michigan’s new surrogacy law brings long-awaited legal clarity to compensated surrogacy. Whether parties work with an agency or independently, the law requires separate Michigan-licensed legal counsel for both intended parents and surrogates. This ensures independent advice and informed decision making. Understanding the compensation terms in surrogacy agreements is an important part of that process.

For questions about the legal aspects of surrogacy, including contract negotiation and parentage, contact Varnum’s Family Law Practice Team. For tax-related questions, reach out to our Tax Planning, Compliance, and Litigation Practice Team.

Equity Compensation for Startups and Early-Stage Employees

Equity Compensation for Startups and Early-Stage Employees

As the startup sector grows increasingly more competitive, equity compensation has become a vital tool for attracting and retaining top talent. Rather than relying solely on cash salaries, early-stage companies often offer equity to align employee incentives with long-term company success. While equity can provide significant upside for both employers and employees, it also introduces important legal, financial, and tax considerations.

What is Equity Compensation?

Equity compensation is a form of non-cash payment that grants employees partial ownership in a company. Startups often provide equity in place of, or in addition to, a traditional salary.

Common Types of Equity Compensation Offered

Understanding the different forms of equity compensation is key for both startups and employees to maximize the benefits and manage risk.

Restricted Stock Awards (RSAs)

RSAs are shares granted to employees, typically subject to a vesting schedule. Employees own the shares upon grant, but they may face tax obligations when the shares vest and again when they are sold.

Stock Options

Stock options give employees the right to purchase company shares at a set price after meeting vesting conditions. There are two main types:

  • Incentive Stock Options (ISOs): Offered only to employees, ISOs may qualify for favorable capital gains tax treatment if holding requirements are met. However, the alternative minimum tax may apply at the time of exercise.
  • Non-Qualified Stock Options (NSOs): NSOs are available to both employees and contractors. They are more flexible but lack tax advantages. NSOs are taxed at exercise and again when the stock is sold.

Why Startups Offer Equity

Startups often operate with limited cash flow. Equity compensation allows the company to attract and retain talent without heavy upfront salary costs. It also helps align employee and company goals.

Benefits of Equity Compensation

For startups, equity fosters a culture of ownership. Employees with a personal stake in the business are often more motivated and invested. Equity also strengthens retention when paired with a vesting schedule.

For employees, equity compensation offers the chance for substantial financial gain if the company grows in value. Favorable tax treatment may also reduce liabilities. In some cases, vested equity includes voting rights, giving employees a greater voice in company matters.

Drawbacks of Equity Compensation

For startups, managing equity plans can be complex and time-consuming. Legal and administrative costs, equity pool dilutions, and reporting requirements can pose challenges.

For startups concerned about the drawbacks of equity compensation, one increasingly common alternative is equity-based compensation. Equity-based compensation still provides incentive by linking compensation to the value (or increase in value) of the company without the issuance of actual ownership. This avoids the multistep process and purchase obligation for options, as well as preventing the creation of more shareholders that can complicate your cap table and dilute ownership for the founders.

For employees, equity does not guarantee financial gain. Shares may become worthless if the company underperforms or fails. Tax obligations can arise at various stages, when shares are granted, exercised, or sold, depending on the equity type. And because equity typically vests over time, employees may need to stay with the company for years to realize full benefits.

Creating a Strong Equity Compensation Plan

A strong equity plan should include:

  • Clear vesting schedules to support retention.
  • Employee education about equity types, tax implications, and exercise timelines.
  • Ongoing compliance with legal and tax requirements.

Equity compensation offers meaningful advantages, but it brings legal and tax complexity. Startups should work closely with legal and tax professionals to create tailored equity plans that align with business goals and protect all parties. 

For help designing or reviewing an equity compensation plan, contact Varnum’s Startup Practice Team.