Introduction to Equity Compensation
By Ben Reynolds
Key Takeaways (Bottom Line Up Front):
- Equity compensation is compensation in the form of company stock.
- This form of compensation seeks to promote an ownership mindset amongst employees, driving aligned incentives and allowing employees to participate in the successes and failures of their company.
- There are various types of equity compensation, but all are rooted in the performance of company stock.
- Equity compensation is a complex topic when considering the various types of plans, tax considerations, key dates, and other considerations.
What is Equity Compensation?
Equity compensation (or, stock-based compensation) refers to compensation in the form of company stock, as opposed to traditional cash compensation like salary or bonuses. While it can be a complex subject, especially when considering the various types, tax implications, and important dates, at its core, equity compensation is simply the practice of paying an employee with ownership in the company.
Why is Equity Compensation Used?
The primary goal of equity compensation is to align the interests of a company with its employees. By offering ownership in the company, employees are incentivized to act in ways that improve the company’s overall success—referred to as having “skin in the game.” This alignment aims to boost productivity, creativity, and efficiency, ultimately driving financial metrics like revenue, profitability, and stock price appreciation.
What are the Types of Equity Compensation?
There are several types of equity compensation plans, but the most common are outlined below:
Restricted Stock Units (RSUs):
RSUs represent a promise to receive shares of company stock in the future, once specific (typically time-based) criteria are met.
Non-Qualified Stock Options (NQSOs):
NQSOs provide employees with the right to purchase company stock at a fixed price (the Exercise Price) after a specified vesting period. NQSOs become valuable if/when the company stock price appreciates beyond the Exercise Price. In this scenario, the employee has the right to purchase company stock at the lower Exercise Price.
Incentive Stock Options (ISOs):
ISOs are similar to NQSOs, but can offer more favorable tax treatment. Provided certain conditions are met, a greater percentage of the taxable gain could be subject to more favorable capital gains taxation opposed to ordinary income taxation.
Employee Stock Purchase Plan (ESPP):
ESPPs are often included in the equity compensation topic because they are an incentive relating to company stock, but there are key differences relative to more traditional equity compensation. Namely, ESPPs are not awarded to an employee like the previously discussed forms of equity compensation. Rather, ESPPs allow employees to purchase company stock through payroll deduction. The benefit of ESPPs is the potential to buy company stock at a discount due to an explicit discount percentage and/or a lookback provision. The latter can make ESPPs especially attractive.
Key Terminology in Equity Compensation
To fully understand equity compensation, it is essential to know some key terminology:
Grant Date:
The date on which the equity compensation is awarded to an employee.
Vest Date:
The date when the employee takes full ownership of the equity compensation and has the opportunity to exercise and/or sell the company stock exposure.
Exercise:
The act of purchasing shares of stock at the option’s Exercise Price. This typically happens after the stock options have vested.
Exercise Price:
The fixed price at which the employee can buy the stock under a stock option plan. The Exercise Price is set at the Grant Date.
Sale Date:
The date when the employee sells the stock acquired through equity compensation.
A bigger story awaits. Make your equity compensation a part of it.
We believe every person can experience bigger possibilities for their life and finances. When true wealth becomes activated by purpose, equity compensation has a role to play in that story. We are passionate about helping you align who you are and what you’ve received in ways that will bring it to life at center stage.
