What Is Equity Compensation?

Quick Answer

Equity compensation is an employee perk that gives you an ownership stake in the company once you meet internal vesting requirements. Equity compensation may include stock options, for example.

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Your salary isn't the only way you might be compensated at work. Equity compensation gives you an ownership stake in the company once you meet internal vesting requirements. This structure can provide built-in motivation to work harder and stay with the company longer—if the organization ultimately does well, that could be good news for your investment portfolio.

What is equity compensation? Think of it as an employee perk that may or may not pay off in the long run. Here's how it works.

How Does Equity Compensation Work?

Equity compensation models can vary. One company may offer it instead of other traditional employee benefits; another may throw it in as a sort of cherry on top. Over a third of private companies offer equity compensation to all their employees, according to a recent Morgan Stanley report. That number jumps to 43% for publicly traded companies.

What's in It for Companies?

Employee benefits can be expensive. Offering, say, student loan reimbursement or quarterly bonuses might be hard for cash-strapped startups. Equity compensation can be a viable alternative that helps attract new talent.

Even companies that already have robust benefits packages can use equity compensation as an extra value-add. It's particularly relevant in today's competitive job market, as it might also incentivize workers to stay at least until they're vested and can fully reap their equity rewards.

What Do Employees Need to Know?

To take full ownership of stock offerings, you'll likely need to stay with the company for a minimum amount of time. Let's say your equity compensation package offers 1,000 shares of company stock. With a four-year vesting schedule, you'd acquire 250 shares after each year of service—and be "fully vested" after four years. Along the way, you can sell shares as they vest, or keep them in your investment portfolio.

It's never guaranteed that your company's stock will increase in value, however. Stock investing is inherently risky, but equity compensation could unlock perks like discounted shares and tax breaks on gains. Beyond that, having an ownership stake in the company might make you feel more connected to its mission. You may be more inclined to do your best work and stay loyal if there are potentially valuable benefits waiting for you on the other side of a rough patch or a vesting period.

Types of Equity Compensation

Equity compensation may include:

  • Stock options: Incentive stock options (ISOs) allow you to buy discounted stock shares. There are also tax breaks on gains if you hold your shares for a certain amount of time. With non-qualified options (NSOs), you won't get such favorable tax treatment.
  • Restricted stock units (RSUs): RSUs don't require you to buy anything. Instead, the company awards you with stock shares (or the cash equivalent) after you hit certain milestones, such as performance milestones or length of tenure. This can pay off big for you as an employee if the stock is doing well when you receive RSUs.
  • Employee stock purchase plans (ESPPs): ESPPs let you buy discounted shares of company stock, but they're structured in a unique way. You use automatic payroll deductions to fund an ESPP account. Once the purchase date arrives, these funds are used to buy company stock at a price that's below market value, usually 5% to 15% lower than what you'd pay buying them on your own.

Pros and Cons of Equity Compensation

Equity compensation presents both major benefits to employees and employers—but it isn't without its drawbacks.

Pros

  • Stock options and ESPPs allow you to buy stock shares at a discounted price.
  • Restricted stock units reward you with stock shares (or their cash equivalent) for meeting performance benchmarks.
  • Having an ownership stake in your company can make you feel more connected to its mission and success.
  • Receiving shares of a stock as part of your benefits package helps you diversify your investment portfolio with little effort.

Cons

  • Owning company stock won't guarantee a future payday or help you avoid market volatility.
  • You might stay at a job you don't love because you're waiting to become fully vested.
  • Accepting equity compensation could mean missing out on a higher salary or other employee benefits.

The Bottom Line

Equity compensation could be a great employee perk, especially if you like the idea of becoming a stakeholder in your company. Just know that you'll probably have to meet certain vesting requirements to get there. That could be problematic for folks who want to leave before they reach that point—or employees who'd prefer other benefits or a higher salary instead.

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