6 Reasons Equity Isn’t Like Cash
Equity compensation is a truly unique element in the total rewards toolbox. I do a lot of work with these plans. The consultants in this space are such a small group that most of us have known each other for years or, in some cases, decades (I am old). We all agree that equity is not as effective as it could be because, so few HR and compensation professionals genuinely understand it. This article boils down to some of the most important things you need to know about equity compensation if you want your programs to work better.
1. Equity is commonly the least equitable form of compensation.
At many companies’ equity compensation values depend primarily on when you started working at the company. If you start early and the company has an established plan and process, your grant may be worth multiple times that of a person who starts just a few weeks later. Negotiations that result in small award sizes differences can magnify into indefensible differences trying to in the future.
2. Specificity is the enemy of accuracy.
This is a saying I have been using for years. Most of the market data for equity compensation is sketchy. The models you use to determine grant sizes and future values are supported by a series of mild to wild guesses. Trying to create base-pay style differences compared to the 50th percentile will result in unfortunate results. Broader ranges and less specific award sizes are some of the best ways to avoid inequity.
3. Equity is a finite resource with near-infinite value. Cash is an infinite resource with a finite value.
You only have 100% of the company to work with. The majority of that will go to shareholders. A chuck will go to founders. You may get as much as 30% of the company to work with, but plan on 15-20% in your equity plan. While your pool is limited, the potential future value can magnify beyond credulity. With Cash, the opposite is true. A great company can always generate more cash. In this sense, Cash is ultimately limitless, but it’s never worth more than the currency being delivered.
4. The risk of granting bigger grants early is low, as long as you…
…are willing to manage your staff. The great thing about equity is that your company gets it back if people leave before vesting. The tricky thing is that you need to vigilantly manage poor performers out or up to ensure your equity pool goes to good use.
5. It is a poor retention tool unless…
…you spend the time and money to ensure people understand their awards and perceive the potential value. The most significant users of equity are tech firms. Tech is also an industry with one of the highest turnover rates. People do not value what they do not understand. Equity compensation is not a magic spell. You need to work at helping people see the value in staying.
6. When you make a mistake, it may be unfixable.
Equity compensation can be unforgiving. If you make a mistake on someone’s base pay, you can correct it and make it up even months later. If you mess up an equity grant or forget to get someone’s shares approved, the stock price movement can result in unrecoverable losses over just a couple of days. If you miss a vesting event or calculate a performance metric wrong, it may not be possible to fix the issue since it may impact taxes, SEC reports, shareholder communications, and so much more.
Equity is an incredibly powerful tool with unmatchable benefits to shareholders, employees, and the company when appropriately used—treating equity like an extension of your cash compensation recipe for failure. Granting equity without understanding its short-term and long-term impact is a recipe for disaster. Equity compensation is an unfamiliar resource, but any compensation professional can learn enough to ensure this pay element is a competitive advantage. Start with the guidelines above to get a head start.
Dan Walter is a CECP, CEP, and Fellow of Global Equity (FGE). He works as Managing Consultant for FutureSense. Dan is also a leading expert on incentive plans and equity compensation issues. He has written several industry resources including a resource dedicated to Performance-Based Equity Compensation. He has co-authored ”Everything You Do In Compensation is Communication”, , “Equity Alternatives” and other books. Connect with Dan on LinkedIn. Or follow him on Twitter at @DanFutureSense.
Posted by DanFutureSense on 08/05/2021 at 06:10 AM in Base Salaries, Compensation Communication, Executive Compensation, Incentives/Bonuses, Small Company Compensation, Stock/Equity Compensation, Total Rewards | Permalink
