An example of equity compensation is receiving stock options from your company, allowing you to purchase company shares at a predetermined price in the future.
Equity compensation is a way for companies to align employee interests with those of the shareholders, incentivize performance, and attract and retain talent, especially in startups where cash compensation may be limited. Instead of (or in addition to) a traditional salary, employees receive a piece of ownership in the company.
Here's a breakdown of common types of equity compensation:
- Stock Options: As mentioned above, stock options give employees the right, but not the obligation, to buy company stock at a specific price (the "grant price" or "exercise price") after a certain period (the "vesting period"). If the company's stock price increases above the grant price, the employee can exercise the option and purchase the stock at the lower price, profiting from the difference.
- Restricted Stock: Restricted stock are actual shares of company stock granted to employees. However, these shares are "restricted" because they cannot be sold or transferred until they vest over a period of time. Vesting is often based on continued employment.
- Restricted Stock Units (RSUs): RSUs are a promise to deliver shares of company stock at a future date, typically after a vesting period. Unlike stock options, RSUs have value even if the stock price stays the same or declines (as long as it's above zero). When RSUs vest, the employee receives the shares, which are then subject to taxes.
- Performance Shares: Performance shares are similar to restricted stock units, but vesting depends on achieving specific performance goals, such as revenue targets, product milestones, or profitability goals. This further aligns employee interests with company success.
- Employee Stock Purchase Plans (ESPPs): ESPPs allow employees to purchase company stock at a discounted price, often through payroll deductions. This is generally offered to a broad base of employees, not just executives or key personnel.
| Equity Compensation Type | Description | Key Features |
|---|---|---|
| Stock Options | Right to buy company stock at a predetermined price. | Vesting period, grant price, potential for profit if the stock price increases. |
| Restricted Stock | Actual shares of company stock with restrictions on sale until vesting. | Vesting period, ownership from grant date, potential for dividends. |
| RSUs | Promise to deliver shares of company stock in the future after vesting. | Vesting period, no upfront cost, shares received upon vesting are taxable income. |
| Performance Shares | Shares that vest based on achieving specific performance goals. | Ties compensation to company performance, higher risk and reward potential. |
| ESPPs | Allows employees to purchase company stock at a discount. | Broad-based participation, discounted purchase price, limited offering periods. |
In conclusion, equity compensation, such as stock options or restricted stock, provides employees with a stake in the company's success, incentivizing them to contribute to its growth and profitability.
