Amidst employee incentives and compensation, equity compensation holds a significant value. You may ask why. For this reason, this post has come with a detailed narrative. So, what is equity compensation?

Equity compensation is the non-cash compensation received by employees. There are certain investment vehicles that can be included in equity compensation. They are Options and Restricted Stock. They also include Performance Shares. These investment vehicles offer employees ownership of the firm. 

In short, equity and competency based compensation may help a company retain employees if there are certain vesting restrictions. What it does is allow them to participate in the earnings of the company via appreciation. 

At times, the lower-than-market pay can be accompanied by stock compensation. 

Multiple public and private companies (especially startups) offer equity pay as an incentive. Equity pay is the strategy by which newly established companies can hire top talent. However, businesses might not have enough funds to invest in cash flow. 

On the other hand, technology companies use equity pay to compensate their employees. No certainty is there for receiving stock remuneration to boost profit. Various firms, big or small, choose private equity associate compensation to compensate employees for their job roles. Let’s find out the benefits in the following point.

Comprehending the benefits of equity compensation

The prime benefit of equity compensation for employees is financial reward. The value of the equity is connected to the stock price of the company. So, the company’s financial benefits might be more significant compared to fixed cash bonuses if the stock price grows. In short, equity compensation benefits employers in the following ways:

Recruitment 

Equity compensation accounting retains top talents and offers financial gains via equity for skilled individuals. Smaller businesses may struggle to compete with big firms, considering the salary packages. So, after the employees grow interested in the firm’s success, they will stay more committed. That way, it benefits smaller businesses who want to compete against larger ones.

Improved productivity

When an employee has an ownership stake in the company, the interests align with its goals. So this fosters a degree of commitment and ownership among employees. They can start prioritising tasks that result in the long-term success of the firm.

Employee engagement

Notably, equity compensation also improves employee engagement. What it does is foster a sense of ownership. When employees feel valued in the company, they are more productive in the decision-making processes. Evidently, they come up with innovative ideas to help the company achieve profits. 

Lower absenteeism

Employees get a direct stake in the performance and company’s success with equity compensation. So, they stay motivated toward their work and are more productive. This reduces absenteeism since employees are more inclined to take on their job responsibilities. They rather work on achieving the mission of the firm.

Better cash-flow management

Equity compensation lets firms conserve cash resources. It offers employees ownership stakes in firms and not conventional cash bonuses. Allocating equity rather than cash lets companies manage their cash flow effectively. It is more beneficial for firms with limited cash flow.

Tax benefits

A few equity compensation plans come with tax benefits for both employees and employers. These benefits include deferring taxes on gains or receiving favourable tax handling on stock awards. Leveraging approved plans helps both the employees and employers optimise tax liabilities and improve the value of equity compensation.

How does equity compensation work?

Do you know how equity compensation works? Well, it works by providing employees with an equity award. One can earn full ownership of a stock by keeping abreast of the company for a specific time. As per private equity compensation reports, there are different equity types. Note that each type has unique characteristics.

Stock options

Stock options are the popular forms of equity compensation. It offers employees with complete rights. However, employees don’t get the obligation to buy company shares at the agreed cost after the vesting period. 

Now, what do you mean by vesting? Well, vesting is a process that lets you earn complete ownership of the award. Considering stock options, the value depends on the stock price and how it performed against that exercise price.

Primarily, stock options are divided into two types. The first is the NSO, and the other is the ISO.

Considering ISOs, they offer tax benefits and are charged when you sell the shares a minimum of two years from the granted date and one year from its exercise date. On the other hand, NSO is taxed if you exercise or sell them.

Restricted stock units

The next type is the restricted stock units. This type comes with less risk as it is granted for free. So, this means that you do not need to buy it. You can earn the share only when you meet the vesting requirements. Note that the RSUs are taxed if you vest & sell them.

SARs & Phantom stock

Now, these are the equity forms that do not use stock. However, they reward employees with compensation. It is tied to the stock performance of the company. 

Thus, the participants aren’t the shareholders. So they do not have any voting rights. The award entirely depends on the appreciation of the stock value or full stock value. As soon as the vesting period ends, you can easily get the cash equivalent or the stock. You need to pay the tax if you sell it.

Performance Shares

The next type is the performance shares or units. It will vest when employees meet their performance-based goals. Such awards are allocated to the executive or director of the company as an incentive to fulfil performance targets.

Employee stock purchase plans

These are used by public enterprises and let participants buy stock in companies at a discounted price. The discount usually ranges between five to fifteen per cent, considering the FMV or fair market value. Non-qualified ESPPs usually are taxed if you purchase and sell the shares. 

Final words

Thus, equity compensation does not guarantee anything when paying off the amount. Unlike the paid salary, you may never be sure whether it will be paid to you or not. But there’s something good about equity based compensation. You can ensure a negotiation considering balanced terms with equity and cash components, which is a great deal.

FAQs