What Is Employee Equity (With Different Types and Benefits)
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There are a variety of ways that employers can compensate their employees for their work. Some companies may offer their staff employee equities. If your employer offers you employee equities as part of your compensation, it's beneficial to learn more about employee equity and how it works. In this article, we answer the question "what is employee equity?", describe different types of employee equity, explain the difference between employee equity and team equity, list some of its benefits, and provide answers to some frequently asked questions about these instruments.
What is employee equity and how do employers offer it?
To answer the question "what is employee equity?", you may consider how employers use this instrument to compensate their staff. Employee equity is the stock in a company an employer may offer to its employees as part of a settlement, salary, or bonus package. This instrument is a non-cash payment, which provides employees with partial ownership in the organization. Employers typically offer employee equity in employee stock options, restricted stock units, and performance shares.
Although equity compensation may initially be comparable to a below-market salary, this form of settlement has the chance of becoming a great investment opportunity for employees. This possibility is because as the company grows, the value of the equity often rises accordingly.
Types of employee equity
A company may offer its employees different types of employee equities. Employers often decide which kind of equity they provide to their employees based on seniority and their role within the company. Common types of employee equity include:
Employee stock option (ESO)
The most commonly offered type of employee equity is an employee stock option (ESO). It's an option because it gives employees the right to purchase future shares in the company at a set price for a limited amount of time, even if the value increases. The employer clearly defines the terms and conditions of ESOs in an employee stock options agreement. There are two primary types of employee stock options, which include:
Incentive stock options (ISOs): ISOs often get preferential tax treatment. Employers typically offer this type of option to senior managers and other senior employees.
Non-qualified stock options (NSOs): Employers usually offer this type of option to employees at various levels of the company since they can consider it as ordinary income. They may offer these options to consultants and company board members as well.
Companies often issue options to their employees during the startup period, when they genuinely want their employees to feel invested in the company and its overall success, or if they lack the funds to offer employees high salaries. Employers may also issue ESOs to their employees if they intend to expand the company quickly and grow the value of their shares. If an employee departs a company before vesting, the options cancel.
Restricted stock unit (RSU)
Employers may offer employees a restricted stock unit (RSU) if they're working for the company during startup or if they have senior positions within the company. Companies issue employees restricted stock units through an investing program or vesting plan. Organizations outline the equity distribution and the conditions that they require employees to meet to receive it. Conditions can include an employee remaining with the company for a determined number of years or once an employee has achieved a specified milestone.
The company stocks have no value until vesting finishes. The restricted stock units have a fair market value (FMV) and both parties can consider it income once vested. Employees pay income tax with part of the shares, and they receive the remaining ones. They can then discretely sell these shares. This form of compensation helps ensure employers retain experienced and talented employees by keeping them at the company.
Employers may offer performance shares to employees in corporate management or executive positions. Employers give performance shares to employees as bonuses or stock options. They're incentive-based and typically reward employees for meeting specific benchmarks or milestones. For example, a company may grant their employees a performance share if they complete a project by a particular deadline or can measurably improve their division's internal performance. When employers offer performance shares, they help align the goals of shareholders with those of their employees. The value of the performance share can fluctuate based on the market.
What's the difference between employee equity and team equity?
Employee equity differs from team equity, as they involve different parties. Employee equity is for employees and rarely involves company founders. Team equity is the division of equity between the founders of a startup. Founders of a company typically divide equity equally amongst themselves. A factor that often influences the division of team equity is the relationship between the founders. For example, if the founders are family members, they likely divide the equity equally. Some other influential factors include the founders':
relative work experience
connections within the field
What are the benefits of employee equity?
When companies include employee equity as part of their compensation plan for employees, both parties can benefit in the following ways:
Benefits for employers
Having an equity compensation plan for employees can benefit organizations because it can:
attract top talent to work for the company
boost employee job satisfaction, as employees feel more invested in the company
improve employees' financial wellbeing
reward employees for working more, so the company
be a useful exit strategy for owners
Benefits for employees
Having an equity compensation plan for employees also benefits the employees, as it provides them with:
the chance to share the company's successes by being equity holders
the pride of being a partial owner of the company, which can motivate them to work better, so the company succeeds
a measurable representation of the worth of their contribution to their employer
the opportunity for tax savings when employees decide to sell their equities (plan-dependant)
Frequently asked questions
Employee equity can be a new concept. Here, you can find some frequently asked questions on the topic that may help you gain a better understanding:
Are there drawbacks to accepting a compensation package that includes equity?
Every company offers a unique compensation package to its employees. These packages can also vary widely by job role. Before accepting equity as part of your compensation package, ensure that you receive a fair and clearly outlined offer. Some employees may dislike compensation packages that comprise equities with lower base salaries, tax liabilities, and time stipulations, but this is standard practice.
Does accepting equity as compensation lead to a lower base salary?
Accepting equity as part of your compensation package may lead to a lower base salary, but this isn't always the case. Companies may offer equity besides a competitive or fair base salary. This offer may occur if a company is trying to hire top talent. It's beneficial to compare the base wage that an employer offers you to the province and national averages.
What if my company offers equity to all of its employees?
If your company is offering equity to all of its employees as a part of their compensation package, this likely means that your share in the ownership diminishes, as there are more owners. The percentage of equity you own correlates to the amount that you can earn. If your company doesn't frequently offer its employees equity, it's likely a better deal, and you can make more in this scenario.
Can a company restrict my access to equity?
Companies can restrict your access to equity, and they often do. Companies control which employees they want to offer equity as compensation to and at what time. For example, a company may provide you with a compensation plan that includes equity, but there may be specific restrictions for when you can access it. An employer may require its employees to work for a determined period to access their equity. They can also prevent employees with high seniority from accessing their benefits for a set time.
Can I negotiate equity into my compensation plan?
Like negotiating a salary or a contract, you can negotiate equity into your compensation plan. Some employees prefer a higher salary, so they may arrange this instead of including equity in their package. Others may prefer more equity and can trade other benefits for an increased share. Ensure that you carefully assess your financial circumstances and research various equity options before negotiating with your employer.
Can a merger affect employee equity?
Mergers can affect employee equity. If you have already vested your shares and have acquired their rights, then a merger may require you to cash out your equity. If your employee equity is an unvested stock, then you may adjust to a different vesting timeline. There is also the possibility of your new employers cancelling your prior agreement to include equity as part of your compensation plan.
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