Why equity compensation?<\/b><\/h2>\n
The major advantage of equity-based compensation is the financial considerations both for the employer and the employee. It allows employers to offer their employees more \u2013 which is great for the employees \u2013 while not affecting their bottom line \u2013 which is great for the employer. More equity compensation benefits:<\/p>\n
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- Helps attract and retain talent<\/b>: It is particularly useful for smaller companies that are just starting out, allowing them to offer employees a portion of their potential when they don\u2019t have much cash to hand. So, they can remain on solid financial ground.<\/li>\n
- Attains greater alignment<\/b>: Employers benefit from the alignment of their employees\u2019 values with the company\u2019s missions.<\/li>\n
- Achieves lower absenteeism:<\/strong>\u00a0Employees work harder and are more productive as their performance impact how much they can earn.<\/li>\n
- Builds employee engagement<\/strong>: Employees likely generate a feeling of team spirit \u2013 they\u2019re not just employees, they\u2019re employee-owners and can often make valuable contributions to the company\u2019s direction through shareholder voting.<\/li>\n<\/ul>\n
Types of employee equity<\/b><\/h2>\n
Employee equity compensation comes in a wide variety of forms and plans \u2013 Stock options, Restricted stock units (RSU), Employee stock purchase plan (ESPP) and more. This post will discuss the following 5 types.<\/p>\n
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- Stock options \u2013 ISOs & NSOs<\/li>\n
- Restricted stock \u2013 RSU & RSA<\/li>\n
- Cash deferred bonus plans \u2013 SARs & Phantom stock<\/li>\n<\/ul>\n
Check how each works in the next section.<\/p>\n
How does equity compensation work?<\/b><\/h2>\n
Equity compensation works by offering employees equity right away when they join the company or after a vesting period where employees have to stay with the company for a certain amount of time to have full ownership of the stock.<\/p>\n
Let\u2019s see how the following types of equity-based compensation work:<\/p>\n
1. Stock options \u2013 ISOs & NSOs:<\/h3>\n
Stock options provide an employee with the right to purchase a certain number of shares at an initially agreed price after\u00a0a vesting period<\/u><\/a>\u00a0(service-based or performance-based or both). Fewer taxes are (often) due for an ISO because no taxes are owed at the time of exercise while taxes are chargeable at exercise for NSOs.<\/p>\n
Financing methods:<\/u><\/strong>
\n1. Cash from the employee\u2019s pocket to purchase the options
\n2. Money made from the sale to cover the exercise costs in an exercise-and-sell-transaction<\/p>\nSuitable for<\/u><\/strong>\u00a0many companies \u2013 early stage, high growth startups and publicly traded companies \u2013 who want to issue equity broadly or with a group of selected employees as a way to attract, retain, and\/or motivate them.<\/p>\n
Learn more\u00a0stock options<\/u><\/a>\u00a0here<\/p>\n
2. Restricted stock \u2013 RSU & RSA:<\/h3>\n
Restricted stock is a grant of shares to an employee. He\/she can receive them only if a vesting requirement is met (service-based or performance-based or both). Participants may need to pay for the grants under RSA plans while they typically receive the grants for free under RSU plans.<\/p>\n
Financing methods:<\/u><\/strong>
\n1. Cash from the employee\u2019s pocket to purchase the grants
\n2. Stock from the company\u2019s equity incentive pool<\/p>\nSuitable for<\/u><\/strong>\u00a0many companies who want to offer equity broadly or with a group of selected employees as a way to attract, retain, and\/or motivate them without requiring payment upfront. (RSA is commonly used by startups while RSU is by established companies)<\/p>\n
Learn more about\u00a0restricted stock (RSU & RSA)<\/u><\/a>\u00a0here<\/p>\n
3. (Cash) deferred bonus plans \u2013 SARs & Phantom stock:<\/h3>\n
They\u2019re the two types of stock plans that don\u2019t really use stock but still reward employees with compensation that is tied to the company\u2019s stock performance. So, participants are not shareholders and don\u2019t have voting rights.<\/p>\n
Once the vesting period is over, participants can get a cash equivalent or the actual stock. If you\u2019re looking to offer plans with minimal risks for employees, they\u2019re ideal because there is no purchase required, unlike stock options.<\/p>\n
- Attains greater alignment<\/b>: Employers benefit from the alignment of their employees\u2019 values with the company\u2019s missions.<\/li>\n
![\"1-year-cliff-vesting-over-4-years\"](\"https:\/\/www.jpmorganworkplacesolutions.com\/wp-content\/uploads\/2021\/02\/1-year-cliff-vesting-over-4-years-1.png\")