There are many ways that a job can attract you to join its team and compensate you for your dedication and hard work. Some common ways are generous salaries, bonuses, and wellness stipends. Another method is issuing employee equity. This form of compensation is often used to attract and retain talent at both public and private companies.
What is Employee Equity?
Employee equity is a way for employees to get a stake in their company. Equity can be offered as restricted stock units (RSUs), performance shares, or options. It is also important to note that employee equity isn’t exclusive to employees–board members and consultants may also receive equity.
How Employee Equity Works
Every company has its own process for employee equity. However, the general process is that stock or options are awarded, and that’s accompanied by a vesting period. Within this context, a vesting period is the amount of time an employee has to work to have full rights to their employee stock. For instance, there may be a three-year vesting period for employee stock worth $5,000. A portion of the awarded stock will usually vest every couple of months until the entire amount is vested.
Founders of a company decide how many company shares will go towards employee equity, so the percentage varies between organizations.
Types of Employee Equity
There are different types of employee equity, but three primary types are employee stock options, restricted stock units, and restricted stock.
Employee stock options
This type of equity isn’t free since employees must pay for it. With employee stock options, employees can buy shares in a company at the strike price instead of the market price. Employees are essentially getting a ‘discount’ on their company stock. If they sell the stock when it appreciates, they can make a profit.
Restricted stock unit
Restricted stock units are grants in the form of stock units given to employees. They also have a vesting period or are promised to employees later. RSUs can be seen as better than stock options since employees don’t pay out of pocket for them.
Restricted stock
Executives and directors typically get restricted stock as a form of compensation. As the name suggests, they tend to have multiple restrictions, including vesting periods, performance goals, and employment lengths.
Benefits of Employee Equity
Employee equity can be an attractive perk for employees and a tool for wealth building. It is also a way to compensate employees and make up for lower salaries. Assuming the company stock does well, the appreciation of the company stock can lead to favorable gains.
When employees have stock in a company, they may feel more motivated to do their best work; when the company stock does well, so do they. Knowing their work contributed to rising stock prices can also spark a sense of pride. Employees may also stick around longer when they own part of the organization they’re working at.
Employee stock can benefit companies, especially startups, which need cash for business operations. By offering employee equity to workers, the company can keep any cash it may have given employees and use it to grow the business.
Risks of Employee Equity
While employee equity has benefits, it can also have disadvantages. Having too much employee equity could throw off your overall investment portfolio. You could be too heavily invested in your company and lack a diversified portfolio.
There are also tax implications since stocks bought or received through employee stock plans are considered income and, thus, subject to income tax. The amount of taxes paid depends on the employee’s tax bracket. Additionally, if employee equity is sold, that could trigger capital gains taxes if the stock has appreciated or a loss if it has depreciated.
Another drawback of employee stock is that it is not guaranteed to perform well. In the case of stock options, if the stock price plummets and becomes cheaper on the market than what you purchased it for from your employer, you may be left with equity that doesn’t hold much value.
If you need help deciding how employee equity fits into your investing portfolio, speak with a financial advisor or planner.
