Understanding Employee Equity Plans

Understanding Employee Equity Plans

For employers and employees, the benefits of company equity plans are extensive. Startups and established companies offer equity compensation for different reasons. 

One common reason is to help companies free up their cash flow through an alternative form of compensation. Equity plans for employees are also a meaningful way to attract quality talent and to ensure those people stay on for the long haul and are motivated along the way. 

When a startup offers an equity plan, employees can feel like they’re helping build the company from the ground up. 

Below, we go into more about the basics of employee equity plans and what to know

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Types Of Equity Compensation

There are three primary types of equity compensation an employer might award

The first is stock options. These can be broken down into subcategories which are Incentive Stock Options (ISOs) or Non-statutory Stock Options (NSOs). These are also known as Non-Qualified Stock Options. 

Restricted Shares can be structured as Restricted Stock Awards or Restricted Stock Units. 

Why Does Employee Equity Have Value?

From the employer’s standpoint and the employee’s perspective, there are great benefits that can come with equity compensation programs. These include:

  • Employee retention and engagement: When a company offers ownership to employees, the recipients can see a direct link between their success in the workplace and their company success, in the form of their stock. It’s a good way to incentivize employees to do their best work and give them ownership in the entire organization’s success. This ownership can also translate to better loyalty and work ethic. 
  • Get the best candidates: Employees are struggling when it comes to recruitment. Equity compensation can be one tool you add to your arsenal to attract the best employees. It may end up being a deciding factor for someone. If you’re an employer,  it’s not only a powerful recruitment tool but it’s also one that’s cheaper than if you just offer more money so you can do more with fewer financial resources. 
  • Tax credits: Equity compensation may reduce your federal tax burdens, and you can save quite a bit of money in the process. For every dollar you issue in the form of equity compensation, you can claim a deduction. 

Are There Any Pitfalls?

Company equity plans are great for the most part but need to be correctly implemented. 

There are a lot of rules and regulations guiding equity compensation. The compliance requirements can vary significantly depending on where you are, and if you’re an international organization, that can become especially burdensome. This can also become more of an issue if you have remote employees in other countries. 

For example, if you have an employee who moves to another country during the vesting period, there are increases in reporting requirements, and there are more reporting obligations for you as the employer. 

Withholding taxes also vary depending on the country. 

A plan administrator will often calculate withholding tax when your employees sell their shares. Then the funds route back to the company. Some countries have higher rates of withholding for equity compensation compared to cash compensation. 

Make Sure Your Employees Know How Equity Compensation Plans Work

If you’re an employer, one thing you’ll need to spend time getting right is making sure your employees understand what’s available to them and they know how the plan works. 

You want employees to understand the benefits of joining, and some may need convincing, or they may need complexities explained to them. 

More About Plans And Benefits

We touched on this above, but there are different types of equity compensation, each with its own features and preconditions. 

Employee stock options let you exercise or purchase a certain amount of shares at a designated price during a particular period if you choose. 

Both incentive stock options and nonqualified stock options fall into this category. Both are usually subject to vesting. The difference is in tax treatments and eligibility. 

With restricted stock units or RSUs, your company grants a certain number of shares on vesting. 

The vesting date triggers tax liability. 

Employee stock purchase plans or ESPPs let employees take advantage of the opportunity to buy company stock shares at a discount over fair market value. 

Performance shares are something where when a company meets certain goals, then employees can obtain performance shares. Performance shares are usually for executives and company leaderships to incentivize them to meet particular targets. 

Stock appreciation rights are similar to a stock option agreement, but you don’t have to purchase the shares. An employee can opt to get a cash payment instead of shares, if they prefer. 

Finally, there’s phantom stock. This replicates the benefits of stock ownership, but you don’t own shares. Your phantom stock value moves in alignment with the actual stock price of the company. You earn cash rewards based on the value of your phantom stock. 

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