Employee compensation and equity compensation can be complex. You want to balance profitability and employee satisfaction not only in salaries but also stock awards.
The following are some things to know about granting equity to employees and how to do it properly.
What Is An Equity Grant?
An equity grant is also known as equity compensation. In very broad terms, an equity grant is a non-cash payment. The receiver, who is your employee, is being granted equity in something.
Many companies want to find effective ways to compensate and motivate employees outside of cash, thus addressing equity grants. Equity awards or stock keep employees happy and engaged and give them a sense of ownership over the work they’re doing.
When you implement equity properly it can align the risk and reward of your employees and help develop long-term value creation as a top priority. Your employees think more holistically about the company’s success, rather than just the day-to-day of their job.
For employers, you can preserve cash as well.
Here general types of equity grants include:
- Stock options: Stock options are also known as employee stock options or an ESO. ESOs are a type of equity compensation where you’re granting employees the option to purchase company shares at a strike price. A strike price is a fixed price available for a specific time window. The employee has an incentive to work in a way that will ultimately increase the value of the stock so they can eventually make a profit when they sell it.
- Restricted stock: Restricted stock is outright owned by an employee when it’s issued. Unlike stock options, the employee doesn’t have to buy it. Like stock options, restricted stocks usually follow a vesting schedule, which motivates employees to stay at the company. There are two types of restricted stock—Restricted Stock Awards and Restricted Stock Units.
- Restricted stock units: RSUs aren’t issued until they’re vested so if you’re the employer, you might create a vesting plan as well as a distribution schedule. There’s no tangible value until the completion of vesting. If there are shares not time-vested and there’s a termination of employment, the shares are forfeited.
The following are considerations for equity grants.
Will You Give the Equity Grant As Part of an Employee Plan?
Some companies will award equity informally to employees, but it’s not that common.
What’s more common is providing stock options under an employer plan. When you grant stock options under an employer plan, the board of directors and sometimes the company’s shareholders have to approve it.
With stock options under the employer plan, they’re also known as an equity incentive or stock incentive plan.
The plans detail the type of equity and the maximum number of shares. There’s also detail about the guidelines.
A top concern for employers right now should be making sure that there are no inequities in employee compensation.
Startup employees have started to be more outspoken when they don’t feel their employers monitor grants across demographics such as gender and race. Many times employers are bringing attention to the fact that employees doing the same jobs and receiving the same base pay receive grants that aren’t proportionate.
The problem is often that the employer doesn’t know there’s an issue because they don’t have visibility into equity distribution. These problems may not come to light until the company goes public, creating serious branding and PR problems.
An early-stage company moves quickly, and monitoring yet more data gets overwhelming.
A solution here is to use software to collect and centralize ownership data. You want reports that are accessible and digestible so you can see comparisons of equity grants with your company’s demographic details.
Time-Vested or Performance-Based?
Companies can use equity awards that vest over time. This strategy provides an incentive for loyalty, promoting retention. If you go with vesting, it’s contingent on an employee staying with you. RSUs vest gradually over time, typically. Vesting might not begin until an employee is with you for at least a year.
Then, after their first anniversary in this scenario, an employee might see their equity award vest monthly. The timeline can be longer too.
A vesting schedule is contractually binding. The cliff period is the qualifying time after a recipient becomes eligible for vesting.
There are different types of vesting schedules, including:
- Immediate vesting where there’s no cliff. Senior leadership employees might be hired on immediate vesting terms. When someone comes on board, and there’s immediate vesting, they might be given a part of the company shares as a bonus or an incentive for a certain performance target.
- Graded vesting: This is what’s most common and there’s a one-year cliff after which point company stocks start vesting in equal monthly increments through the period of, let’s say, four years, until reaching 100%.
- Cliff vesting grants equity awards at once but only after the end of the cliff period. This can work well for a short-term employee like a consultant.
How Much Equity Will You Assign to Each Employee?
As a startup, you might determine the amount of equity you’re going to grant based on factors like roles, skillset or seniority.
If you’re bringing employees onboard in a startup, they’re taking a tremendous risk given the high failure rate. You want to make sure you’re reflecting this in your equity assignment.
The earliest employees may get the most equity, which could go down from there.
Finally, make sure you’re using a cap table to document equity. A cap table is a record of all company shareholders, including employees, investors and advisors. It might include angel investors and friends and family.
Your cap table will have the total number of stock options already exercised and the shares still available. You should update this document regularly to make sure it reflects your current ownership accurately.