Find the answers to common questions your employees have about equity compensation
Equity compensation is a powerful tool for motivating and rewarding your team, but it's essential that you get the details right. Here are some best practices to help you use equity effectively in your company.
Employee equity compensation is one of the most popular employee benefits companies offer, but it’s also very complex. If you’re an HR manager trying to understand this topic or an employee trying to educate yourself about this topic, you’ve come to the right place. In this blog post, we’ll answer your most commonly asked questions about equity compensation in simple, easy-to-understand terms. Editor’s note: Want to know more about equity and stock options? Download our free eBook to help you better understand employee equity compensation.
Let’s start with the basics. Equity compensation is non-cash pay that gives employees an ownership stake in the company. It can be in various forms, including options, restricted stock, and performance shares.
Equity compensation is most commonly associated with startups, but private and public companies offer it. It’s a popular option for organizations who want to attract and retain talent, but either doesn’t have enough cash flow or want to invest their profits into its growth. By giving employees equity as part of their salary, employers can supplement the base salaries and give people the chance to share in the company’s profits through appreciation.
There are 3 common categories of equity compensation:
This is an offer that gives employees the right to purchase (“exercise”) shares of a company’s stocks at a predetermined price (“strike price”), subject to specific time limits and conditions. There are two types of stock options:
ISOs are a type of stock option that gives employees the right, within a designated timeframe, to buy a set number of their company’s shares at a predetermined price. ISOs can only be offered to employees.
NSOs are a type of stock option that gives employees the right, within a designated timeframe, to buy a set number of their company’s shares at a predetermined price. NSOs can be offered to both employees and non-employees.
This is a company-run program that offers employees the ability to purchase company stock at a discounted price. To participate, employees contribute to the plan through payroll deductions and, on the purchase date, the company uses the employee's accumulated funds to purchase stock in the company at a discount.
Restricted Stock Units (RSUs) offer employees (typically at larger, public companies) a set number of shares of stock at a future date, upon the completion of a vesting schedule. Unlike options, employees don’t have to buy RSUs—they’re just given. Restricted Stock Awards (RSAs) give early employees (typically at startups) a set number of shares of stock, at no cost on the grant date or at a discounted price.
Vesting refers to the period of time an employee must wait to fully exercise their rights to certain assets. Vesting periods are typically applied to stock options, RSUs, retirement funds, and certain benefits.
Every type of equity compensation has slightly different tax implications. Here’s a high-level overview of tax considerations for stock options and restricted shares.
ESPPs are a bit different. The specific tax impact of disposing of ESPP stock will vary depending on four factors:
For a more in-depth guide on taxes, check out our guide to understanding equity compensation.
There are a few factors employees have to consider when it comes to understanding the value of their equity compensation:
To understand the value of their equity, the employee has to know their percentage of ownership. To calculate percentage ownership, take the number of shares offered and divide by the total number of fully diluted shares outstanding.
Once the percentage ownership is calculated (i.e. 0.001%), multiply it by the company’s current valuation to find the value of the options. Keep in mind that the strike price, taxes, and other factors may affect the amount.If your employee is looking for a simpler way to calculate this number, Origin’s Equity Manager has a simulator tool that projects the value of equity holdings based on company growth scenarios that employees can manipulate directly.
Another factor to take into consideration is the vesting period. Most stock options have a four-year vesting schedule and a one-year cliff. In other words, employees own zero options in their first year of service. After their first year with the company, they’ll receive 25% of the options they were granted and then incrementally more every month until they reach four years. This will also determine the value of their stock options. Keep in mind that if an employee leaves the company for a new job, gets laid off, or retires, they typically have a window of 90 days to exercise their options. If they’re not exercised in this timeframe, they expire.
Also, it’s important to note that these valuations only matter if the company ultimately has a successful exit—whether that’s through an IPO or acquisition. So the employer shouldn’t assume their stock options will be worth any significant amount during their time with the organization.
In the simplest terms: after a company IPOs, an employee will be able to sell their stock options. When a private company is about to go public, there are a few things employees should do to prepare for this transition:
For stock options, employees typically have one of four options:
It’s critical for employees to have a trusted financial advisor who can help them understand their equity compensation and guide them toward the right decisions, depending on their financial goals. However, financial advisors are out of reach for most people. Another way to support employees—especially if your company is planning to IPO soon—is to introduce Origin as a benefit. Our Equity Manager product contains a suite of tools that allow employees to get a comprehensive overview of your equity, educate themselves, and even simulate the value of their compensation over time. Our platform, paired with personalized guidance from our network of CFP® professionals, will empower your people to make the most informed and confident decisions about equity compensation.
Hopefully, this article answered some of your most common questions about equity compensation. Having this basic knowledge can make a huge difference in educating your employees or understanding the value of your stock options. Want to learn more about the ins and outs of equity compensation? Download our guide.