Equity-based compensation is non-cash pay that represents ownership in the company that employs you. It can be referenced and awarded in many ways, including stock options, restricted stock units, performance stock units, and employee stock purchase plans (ESPP). Tying certain employees’ compensation to the overall success of the company can be seen as both a retention and motivational strategy.
Publicly-traded companies often award stock options to their key employees and executives. Stock option awards give employees the right to purchase a specific number of shares of their company’s stock at a predetermined (strike) price. The strike price (also known as the grant price) is typically the market price of the stock on the date the grant was awarded.
A vesting period for stock option awards is generally required, although each plan will have its own vesting structure and duration which can be found in the program agreement. Once the shares are vested, option holders can decide when to exercise the options. The objective is to capture value over time, but if option holders do not exercise the options before the expiration date then they will expire and be worthless.
Restricted Stock Units
The issuance of restricted stock is an unfunded promise to grant the recipient shares of stock at a predetermined point in the future. The restricted stock units have no value when promised and the holders have no voting rights and do not receive dividends, although some companies will pay an amount equivalent to the dividends paid to stockholders during the vesting period.
When the restricted stock units vest, they are distributed as either shares of stock or the cash equivalent. The recipient pays taxes on the value of the shares at the time of vesting through their employer payroll and the tax rate is that of ordinary income.
Performance Stock Units
Performance stock units are essentially restricted stock units that are issued based on company performance as measured against predetermined goals. Unlike restricted stock, the amount of shares an employee will receive is not finalized at the time the promise is made. Instead, the employees’ performance against a set of goals will determine the ultimate grant amount.
Employee Stock Purchase Plans (ESPP)
Through an ESPP, employees may purchase company stock at below-market prices. The discount can be up to 15% lower than market value and the plan may be qualified or non-qualified. While qualified plans have the greatest tax advantage, they also operate under more stringent regulations than a non-qualified plan.
Certain restrictions will also direct who is eligible to invest in the ESPP. There is typically a one-year waiting period before an employee may buy into the program, and people who already own a large share of company stock (usually 5%) are ineligible. Participation is completely voluntary and employees may decline the opportunity to purchase stock through an ESPP when offered.
How a Company Benefits from Equity-Based Compensation
By linking the value of a stock award to the company’s stock performance, an employer incentivizes employees to remain at the company and also to work towards company growth. Oftentimes equity compensation is used as a retention tool as there is typically a vesting period where the employee must remain active with the company to receive their awards.
Many agreements also include a shortened expiration timeframe should the employee leave the company prior to meeting the criteria for retirement.
Managing Equity-Based Compensation
SYM Financial can help you to optimize your equity-based compensation. Using a proprietary process, we work to extract optimal value from equity compensation awards and complete an annual deep dive with a full fundamental and technical analysis of your company stock positions. For more information visit us at sym.com or call 800-888-7968.