What Employers Need to Know About Equity Compensation

At its core, compensation is about rewarding employees for helping your company achieve its goals. While salaries are important, they often fall short of driving true engagement. That’s where equity compensation comes in. By offering your employees a stake in the company, you can encourage them to think and act like owners, boosting both motivation and retention. 

In this article, we’ll explore all of the benefits equity compensation could bring to your business, some key considerations to keep in mind, plus some of the different types of employee equity plans you could put together. 

Ready? Let’s dive in. 

‍

What is employee equity? 

‍

Employee equity is a powerful form of compensation that turns your employees into part-owners of the company they work for. While equity compensation can get pretty complicated, the basic concept is straightforward. It involves either: 

• Giving employees shares (stock) in the company
• Giving employees the chance to buy shares at a discounted rate

Employee equity schemes typically involve a vesting period, which is a set length of time employees have to stay at the company before they can access their equity. In some cases, they may also need to hit specific performance targets or milestones to qualify. 

In some countries, there are specific equity schemes that come with significant tax advantages for employees. In France, for example, the BPSCE (Bons de souscription de parts de créateur d’entreprise) is a special scheme that allows employees to defer paying taxes until they sell their shares for a profit. Additionally, only the ‘gain’ — the increase in value between the purchase and sale price — is taxable. 

‍

Benefits of offering company equity to employees 

‍

Putting together an equity compensation plan can be a complex and time-consuming task for an employer. So why bother? Here are a few of the major advantages of equity compensation from an employer’s perspective.

‍

Helps to attract top talent 

By offering employees a stake in the company, you provide them with the potential for significant financial rewards as the business grows. This can make your company an attractive option to prospective employees, particularly in competitive markets. 

‍

Makes up for lower salaries 

Equity compensation is an especially powerful tool in the startup world, where employers can’t always afford to compete with big players on salary. By giving employees a share in the company’s future success, smaller companies can effectively compete for talent even when cash flow is limited. 

‍

Boosts retention of key employees

Equity compensation usually involves a vesting period, which means employees need to stay with the company for a set amount of time before they can fully benefit from their equity. This structure encourages employee loyalty and helps to retain key people for longer. 

‍

Improves employee motivation

When employees have equity in the company, they’re not just working for a paycheck — they’re actively trying to grow their own investment. This sense of ownership can significantly boost motivation and encourage employees to contribute to the company’s success. 

‍

Aligns employee incentives with business interests

With equity compensation, employees’ financial interests are directly tied to the company’s growth. This encourages employees to focus on the long-term success of the business instead of getting distracted by short-term wins. Over time, this could significantly boost your company’s performance.

‍

Key considerations for designing an employee equity plan 

‍

There’s no denying it: equity compensation is complicated. But as we’ve seen, the rewards for both your employees and your business can be significant. Here are a few things to keep in mind as you put your employee equity plan together. 

• Tax implications: Depending on your location, employees may owe taxes when they receive shares, when they sell them, and even when they receive dividends as shareholders. Untangling and understanding these tax implications is a key part of putting together your equity compensation plan.

• Vesting periods: This is the length of time employees have to wait before accessing their equity, which is typically 3–5 years. You should ensure your vesting schedule aligns with your company’s strategic goals, whether you’re focused on short-term milestones or long-term growth. 

• Performance metrics: Some plans require employees to meet specific performance goals to earn equity. Setting clear, achievable targets that are aligned with your business objectives can drive motivation and make the equity plan more compelling for employees. 

• Share dilution: Dilution is when the relative ownership of a company for existing shareholders is reduced because new shares have been created. Employers may need to consider how adding new shares could impact their other shareholders. 

• Liquidity: Liquidity refers to how easy it is for an employer to convert an asset (i.e. company shares) into cash. Different types of employee equity schemes have different levels of liquidity, and it’s important to think about this when putting your plan together.

• Regulatory and compliance issues: Every country has its own regulations when it comes to employee equity plans, including employee rights and employer reporting obligations. Navigating these rules effectively is crucial to avoiding pitfalls.

• Employee support and education: Employees aren’t always clued up on the intricacies of equity plans or the stock market. Providing educational resources and financial planning support can empower them to make informed decisions, increasing the value they get from your equity plan.  

‍

Different types of equity compensation 

‍

The types of equity plans you can offer depend on the laws and cultural norms in your country. As we’ve mentioned, some regions provide tax-advantaged schemes that could maximise the financial benefits for your employees. Here are a few common categories of employee equity plans you might consider: 

‍

Employee stock purchase plans (ESPPs) 

An ESPP is a company-run programme that allows employees to buy shares at a discounted price. Employees contribute to the scheme through regular payroll deductions. After a certain period, the company uses the accumulated funds to purchase stock on the employee’s behalf. ESPPs are usually only available to employees who have been with the company for a certain period, such as one year. 

‍

Employee stock ownership plans (ESOPs) 

In an ESOP, employees receive shares in the company after certain milestones. For example, they may receive 20 shares after their first year of employment, and 100 shares after five years. These shares are held in a trust by the company until the employee leaves or retires, at which point they receive a lump sum or periodic payments for the value of their shares. ESOPs encourage retention since employees can’t take shares with them when they leave the company.

‍

Stock options 

Stock options give employees the opportunity to buy shares from the company during a set period called the exercise window. Employees can purchase these shares at a fixed price (the strike price), which is often significantly lower than the market price. They can then sell these shares at a profit. 

‍

Restricted stock units (RSUs) 

RSUs are shares that are granted to employees after a vesting period. Employees typically need to meet certain tenure or performance criteria to receive shares, which are granted according to a set vesting schedule. For example, they may receive their shares all at once (known as ‘cliff vesting’) or gradually over a period of several years. RSUs offer a safer option for employees since they’ll be able to retain some value even if the company share price has dropped. 

‍

Performance stock units (PSUs) 

PSUs are similar to RSUs, except that they’re awarded based on the company’s performance over a certain period. This is typically three years. Employers may use metrics like shareholder return or earnings per share to determine the company’s success. PSUs incentivise employees by directly tying their financial interests to the company’s performance, aligning their motivations with the company’s goals. 

‍

Phantom shares

Phantom shares (or virtual shares) are a way of rewarding employees for the company’s success without actual stock ownership. After a vesting period, employees receive a cash benefit based on the company’s share price. Because it doesn’t involve purchasing or transferring shares, offering phantom stock is a good option for companies with limited administrative resources or those in countries with complex tax regulations. 

‍

Getting the balance right: the importance of total compensation 

‍

Equity is just one part of an employee’s total compensation package, which may include a base salary, bonuses, benefits, commissions and more. Striking the right balance between all of these elements can maximise your ability to attract and retain top talent and drive high performance across the organisation. 

Of course, there’s no single formula for balancing compensation. The mix you choose should align with your compensation philosophy, which outlines the goals you want to achieve through compensation. In turn, this should be closely tied to your company’s mission, vision, strategy and core values — which are different for every organisation. 

‍

Learn more 

‍

Want to dive into other key elements of employee compensation? We’ve got you covered. Here are a few articles from our archive to get you started: 

• How to Support Employee Financial Wellness
• Understanding Earned Wage Access: A Guide for Employers
• Executive Compensation 101: What You Need to Know
• Long-Term Incentive Plans: What’s the Deal?
• Demystifying OTE Salary: What Does OTE Mean and Why It Matters

‍