Understanding Employee Stock: What are the Forms of Equity Compensation?
Competitive compensation goes beyond basic pay. Many key hires are not swayed by the amount you can pay them but by other forms of compensation.
Equity compensation is an excellent option for companies looking to attract high-level talent, especially for SMBs and startups. If you're looking for ways to attract prospective hires and retain personnel in your company, check out the different forms of equity compensation you can offer.
Stock Options
The most basic form of equity compensation is stock options. As compensation, employees are given some company stock and become partial owners of the company, which can also be part of an innovative rewards program with the potential to retain motivated employees.
Stock options can be valuable when the stock's price appreciates or if the stock yields regular dividends. Stock options come in two types:
Common stock - Common stock is what most people are familiar with. You purchase a company's stock, and you gain voting rights as a partial owner of the company.
Preferred stock - Preferred stock is more income-oriented. When someone owns preferred stock of a company, they don't gain voting rights, but they are paid dividends before common stock shareholders.
Offering stock options to employees is usually preferred by early-stage, high-growth startups. It is a common practice for tech companies with projected meteoric growth.
Restricted Stock Units
Like stock options, restricted stock units are a form of equity compensation where the employee is given company shares.
However, unlike stock options, restricted stock units follow a vesting plan with a distribution schedule depending on fulfilling a specific condition, usually a particular achievement at work, a milestone in the company, or a fixed duration/vesting period.
Unlike stock options, restricted stock units have no value until the vesting is complete. Fair market value is assigned when vesting begins, after which a portion of the shares is withheld to pay for taxes, and the rest is given to the employee.
Companies commonly utilize this type of equity compensation to encourage employees to stay with the company long-term and to drive performance to increase share value.
Employee Stock Purchase Plans
Not all employees enjoy equity compensation. An excellent way to offer equity compensation to employees who want it is by offering an Employee Stock Purchase Plan (ESPP).
This type of company program allows employees to purchase company stock at an employee discount compared to fair market value. This is a good way of encouraging employees to become more invested in a company's performance and growth while offering a company some liquidity.
Among the industry leaders who offer this type of compensation is Tesla. As part of its employees' compensation package, Tesla offers stock options through ESPP.
Stock Appreciation Rights
Another way to compensate employees with equity is by giving them all the benefits of owning a stock without having to purchase it themselves.
Stock appreciation rights are a type of equity compensation where employees are paid the excess amount of the fair market value on the exercise date over the grant date. Unlike regular stock options, stock appreciation rights don't require a cash outlay. They incentivize employees to retain them.
Phantom Stock Units
Another way to compensate employees, usually executive hires, is by giving them phantom stocks or mock stocks.
As the name suggests, phantom stock units offer the same benefits as owning company stock without actually owning company stock. This means that employees can enjoy large cash payments without diluting the company's equity.
Phantom stock plans come in two forms, appreciation only and full value. Appreciation only phantom stocks refer to a payout equivalent to only the excess value of the fair market value of the company stock on the exercise date compared to that of the grant date.
Meanwhile, full-value phantom stocks refer to a payout equivalent to the value of the underlying stock and the value of appreciation.
Deferred Compensation
Equity compensation doesn't always come in some form of company shares or stock. A good example is deferred compensation, which is commonly offered to executive hires.
Deferred compensation is the practice of setting aside a portion of an employee's compensation to be paid out at a later date for tax benefits.
Some examples of deferred compensation plans include retirement plans, pension plans, and deferred savings and stock-option plans.
Companies usually offer deferred compensation plans to employees to hold onto key employees whose tax situations could benefit from the deferment.
Equity Compensation Consulting
Despite the benefits of granting equity compensation, it also has its fair share of complications. In most cases, companies need to consult professionals to guide them along the way. If you're new to this, take the time to understand the purpose and process to ensure long-term success.
Does your company wish to offer equity compensation to your employees? Reach out to Dan Walter, Managing Consultant at FutureSense today to learn more about how our equity compensation consulting services can help you improve your hiring competitiveness, employee satisfaction, and retention.
About FutureSense
FutureSense is a management consulting firm that provides integrated solutions to build and sustain human capital capacity. The firm can work with you by offering support and guidance to manage your workforce. To learn more about FutureSense, please visit FutureSense.com.