Equity Compensation
While equity compensation can be a valuable part of your compensation package, it's important to approach it with realistic expectations and to negotiate carefully. By understanding the details of your offer and comparing it to the company's overall share structure, you can determine if the equity compensation is fair and aligns with your career goals.
First things first, congrats on the job offer, HENRY! The hardest part of getting a new gig is over (no more pretending that your is caring TOO much, phew). We’re here to help you with another hard part—understanding equity compensation and negotiating it if necessary.
Also called stock-based compensation, equity compensation is when an employer offers you some sort of partial ownership in the company, usually in the form of stocks, in lieu of a higher salary. This is especially common in start-ups, which are often strapped for cash.
You’ve probably heard some legendary tales about equity comp, like that guy from your gym who doesn’t need to work anymore because he was one of Twitter’s first employees and made millions when they went public. But those success stories are unicorns. It’s important to understand the details of your offer before fantasizing about an early retirement.
Equity compensation isn’t a scam, but it does benefit the employer
We know what you’re thinking—nothing is better than being paid in cold, hard cash—and you’re right to be skeptical. Companies offering equity comp are usually doing so because it helps them with their cash flow, especially in the start-up phase. They may not be able to offer you as high a salary, so they’re trying to woo you with something that you can’t take to the bank right away.
But there are other good reasons to offer equity, too. It can be more motivating to employees. When you have a stake in the company’s success, you may be more inclined to work hard to achieve it. And getting in early, before a company goes public or before it becomes very profitable, can lead to big payouts. This is rare, though, and probably shouldn’t be a determining factor in your decision to accept a job.
There are several types of equity compensation, and some are better than others
Before we explain the different types, let’s talk about how equity is paid out. Generally, you are either granted equity immediately, or you receive it on a vesting schedule. Vesting schedules can be riskier because they require you to put in a certain amount of time before receiving any equity. Consider how long you plan to stay at the company before moving forward with any such deal.
Ok, onto the types of equity compensation you might receive:
Stock options
These are, well, exactly what they sound like. You are given the option to purchase, or exercise, stock in your company at a certain rate. There are two common types of stock option plans: Incentive stock options, or ISOs, and nonqualified stock options (also sometimes referred to as nonstatutory stock options, both terms are cute ways of saying there are no tax advantages).
ISOs are only taxed at capital gains rates when you sell, meaning you only pay taxes on any earnings your investment made above the original investment. If you hold your stock longer than a year, you would pay more favorable long-term capital gains rates.
Nonqualified stock options, on the other hand, are taxed at ordinary income rates when you buy the stock. This basically means the purchase is treated as part of your salary and taxed accordingly. Then once you sell the stock, you will have to pay capital gains taxes on any earnings.
Restricted Stock Units (RSUs) or Restricted Stock Awards (RSAs)
RSUs and RSAs are trending right now, especially at larger companies. RSUs are usually distributed on a vesting schedule and taxed at ordinary income rates. If the company hasn’t gone public yet, you may get stuck paying taxes on stock you can’t sell yet (or maybe ever, if the company goes under).
RSAs, on the other hand, are granted outright, but you may still need to purchase the shares even though you “own” them.
Don’t confuse either of these with restricted stock, which is a different thing we won’t waste your time on right now.
Employee stock purchase plans
ESPPs allow you to purchase shares of company stock at a discounted rate in certain timeframes, usually by taking the money right out of your paycheck. The company will buy stock for every employee participating in the plan, and you’ll be taxed at ordinary income rates on the discounted amount, and again at capital gains rates when you sell.
Performance shares
Another obvious one, and one usually reserved for big whigs. With performance shares, you must achieve certain metrics to receive the award, so you’d better be pretty confident you’re up to the task.
Should you negotiate your equity compensation?
More shares aren’t necessarily better when it comes to equity comp; it’s the number of shares you’re being awarded compared to the total number of shares the company has issued that matters.
Ask your potential employer how many “fully diluted shares” the company has. This is the number of shares the company has now, and how many more they may issue in the future. Compare that to the number of shares you’re being offered to determine what percent of the company you’d own.
If you’re not happy with that number, or with the type of equity comp you’re being offered, it may be worth asking for more equity, a higher salary, or some other perk. And don’t be afraid to walk away if they’re unwilling to negotiate. That’s usually a good sign they’re not going to be a great employer anyway!
Have a particularly complicated employment situation? A Stash Plan can sort sh*t out for you.
Stash Wealth provides financial plans designed to assist high earning young professionals build and manage their wealth.
Stash Wealth offers a pragmatic approach to financial planning and wealth management. Whether saving up for Tahiti or a Tesla, we help you achieve your short-term and long-term goals.
Written by Stash Wealth Staff Writer
Stash Wealth Staff Writers are knowledgeable about personal finance topics. Their objective is to unravel the complexities of finance trade jargon, products, and services in order to equip HENRYs with a sound understanding of financial matters.
