Employee’s Guide: How to Benefit from Equity in Your Company

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By Laura Tanner, PhD, CFP

Learn more about Laura on NerdWallet’s Ask an Advisor

This is the first article of a series of posts on how to benefit from equity in your company.

The purpose is to help you understand the details of your long-term incentive (LTI) plan, and to empower you to make informed decisions on how to benefit from ownership of stock in your company.  The blog title “Smart but Clueless About Money” comes from my experience as a former research scientist, where some of my colleagues, who were intelligent and well-educated, were baffled by their plans.  If you feel that way, you are not alone!

Part 1:  The Basics of Company Equity

On the TV show “Shark Tank“, entrepreneurs pitch their business concept to a panel of investors, with the goal of getting cash to build their business.  What do the investors get in return?  They get partial ownership in the company (i.e. equity), and an opportunity to participate in its growth (or failure).  There are ruthless, rapid-fire negotiations over the amount of equity the investors will get as part of the deal.  That’s because there can be significant upside potential for the investors.

If you are working at a company which offers a long-term incentive plan (which may include stock options or restricted stock grants) as part of your benefits package, you may also gain from your company’s success.  However, unlike the investors on “Shark Tank”, you are earning equity in the company through your labor, rather than through investment of money.  In addition, you are most likely receiving a salary, and company stock is a bonus.

Overview of long-term incentive plans

LTI plans (also known as equity compensation) are part of the benefits package used by some companies to attract, reward and retain their employees.  These plans are popular with start-up companies, who are cash-poor (like the entrepreneurs on “Shark Tank”).  Rather than spending their venture capital funds on hefty salaries, they use this money for building the business and promise employees equity in the company, in addition to a more modest salary.  More established companies will also use LTI plans to remain competitive and attract and retain the best people.

Types of equity compensation include options (incentive (ISO) and nonqualified (NQSO)), restricted stock, restricted stock units (RSU’s), stock appreciation rights (SAR’s), employee stock purchase plans (ESPP’s) and performance shares.  Stock options, restricted stock and RSU’s are the most common forms of equity compensation.

Employee stock options and grants are usually offered at the time of employment, with additional issues over subsequent years as a bonus and to retain employees (due to vesting requirements).

Vesting

Vesting is a way for your company to encourage your continued employment with them – i.e. “golden handcuffs”.  You must meet certain criteria to qualify for outright ownership of stock options and grants.  Conditions are usually based on your length of employment.  Vesting schedules can either be graded (example: 25% vests each year for four years) or cliff (example: all options or grants vest after 3 years).  For higher-level employees, vesting can be based on your performance (measured by company share price, for example).

Future posts will include more details on different types of equity compensation, tax planning, and strategies for success in managing your LTI plan.

Recommended Resources

myStockOptions.com

Consider Your Options by Kaye A. Thomas, Fairmark Press (2010)