Companies have the opportunity to provide equity compensation for employees. Equity compensation is any compensation that’s comprised of company equity rather than a cash payment.
Equity compensation can include incentive stock options, restricted stock bonus or purchase plans, stock purchase plans, and non-qualified stock options.
From the employer’s perspective, equity compensation allows you to attract and retain strong employees without offering as much for their salary. If you’re a company considering equity compensation, you do have to manage it properly. To do that it’s a good idea to use software specifically for cap table management.
If you’re an employee and you’ve been offered equity as part of your compensation package, to put it simply, you’re offered shares of stock or the option to buy shares. Equity compensation gives you stock ownership as a payment. This is relatively common among startups because they have limited cash flow. The offering of equity can supplement your cash compensation.
Equity compensation typically follows a vesting schedule. You own your equity after a period of time when there’s a vesting schedule.
Salary, in contrast to equity, means money is deposited into your account for your work. Equity refers to the worth of the business, so your stock and equity as an employee is your individual share of your employer’s total worth.
In general, what are the pros and cons of equity compensation, particularly from the employer’s perspective?
Benefits of Stock Options
With equity stock options, if you’re operating a startup, this could be one of the ways to attract top talent, despite your limited budget. Having partial ownership in the company is also good in that it can boost employee loyalty and drive productivity.
There’s the idea with equity compensation that it’s going to make employees work that much harder because they’re sharing in the success but also potentially the failure of the company.
You can also reduce employee turnover, depending on your vesting schedule.
When you use equity compensation early on in your startup, you can reduce the money you’re paying for salaries. You can also reduce the need to raise funding.
As an employee with equity compensation, it’s like you’re becoming a partner in the business. You may feel more compelled and engaged in making sure the company succeeds since you do potentially get to share in whatever that success looks like.
What are the Disadvantages?
From the employer’s perspective, and perhaps even that of the employee, equity-based compensation is complex. We touched on this briefly above. You can overcome some of that complexity by using software to manage your compensation program.
You also have to think about securities and anti-fraud laws, so you’ll likely need to consult with a securities attorney. Talking to a tax attorney can also be helpful because the tax implications get complicated.
When an employee with equity leaves, you have to restructure in a way that once again becomes complicated.
Selling your company is also more difficult if you’ve given away equity because many buyers want to buy all of a company.
You could have one of your equity-holding employees be against the sale, for example. At the same time, your employees’ shares have essentially no worth until you either sell the company or take it public. Employees could be pushing you to sell as a result, even if you don’t necessarily want to.
As an employer, you’re going to be giving up privacy when you have shareholders. You’re going to have to provide access to your books to your employees who hold equity.
Once you turn profitable, you could find yourself in a situation where you gave away too much of your company.
For employees, there are several downsides to think about. First, you could be giving up higher compensation in the form of a salary. Is this something you’re willing to do?
Finally, you’re also going to potentially be limited in what value your equity shares can bring to you. For example, a vesting schedule is more than likely part of the deal. Employers aren’t going to typically award stock options or grants on the first day you start working for them.
Rather, you receive your equity compensation over a period of time which is the vesting schedule. You’re accepting a fair amount of risk when you say yes to equity compensation, and you’re not going to be able to liquidate your shares immediately.
______________________________________________________________________
Some other articles you might find of interest:
Make your business rock with these business plan writing skills:
Startup’s Guide to Write a Business Plan
Would you like to know how investors value a startup?
How Do Investors Value a Startup?
