Equity payments: understanding its benefits and drawbacks

Have you ever wondered that companies offer employees? You have  heard the term "stock options" thrown around or "RSUs" and are not  quite sure how they work. Indeed, you have found the right place.  Instead of just receiving a paycheck, some companies opt to give employees equity payments as a kind of compensation.

Read on to finally understand this key aspect of your employee benefits.

Why Do Businesses Offer Equity Payments?

The answer is simple. Employees receive stock options or equity payments for staying with a company.

But there is more to this. Companies provide equity for the following reasons:

• Aligns employees' interests with the company's success. When the company's stock price goes up, employees’ benefit. This motivates employees to work hard to improve the company's performance.
• Attracts top talent. The opportunity to own part of a company and share in its success is appealing to many candidates. This is especially true for startups trying to draw in  experienced hires.
• Retains employees. Equity takes time to vest, so employees have an incentive to stay with the company to get their full share. This reduces turnover costs for the company.
• Conserves cash. Rather than paying higher salaries, companies can offer equity. This is useful for new companies short on funding. Equity is a way to compensate employees without major cash outlays.

Equity payments are a strategic way for companies to motivate, retain, and attract the best employees while aligning their commercial interests with the organization. Equity payment gives workers a share in their company's success and worth. It is a win-win when done well.

How Equity Payments Work: Restricted Stock Units and Stock Options

As an employee, the company may offer equity payments like restricted stock units (RSUs) as part of your compensation package. These give you the potential to share in your company’s success.

How RSUs Work

RSUs represent shares of your company’s stock that they granted to you at no cost. They “vest” (become yours) over time as long as you remain employed. For example, RSUs may vest over 4 years, with 25% vesting each year. Once granted, the shares are yours to keep or sell. RSUs have value as soon as you receive them.

How Stock Options Work

Stock options give you the right to purchase company shares at a fixed “strike” price within a certain time. They only have value when  the stock price rises above the strike price. Options vest over time and once vested, you can “exercise” them by paying the strike price for the shares. You can then keep or sell the shares. Options are only taxed when you exercise and sell the shares for a profit.

Equity payments reward employees for their contributions while giving them an incentive to stay with the company long-term. The potential payout can be huge when the stock price skyrockets! When  the stock price does not improve much, the equity payment may bring little advantage. To take advantage of these initiatives, employees must understand how they work.

The Benefits and Drawbacks of Accepting Equity Payments

The main benefits of accepting equity payments are the potential for high returns and sharing in the company's success. You own part of the company as an employee. As the company's value rises, so does your equity stake position. This can translate into a big payoff when  the company goes public for acquisition. You  may get voting rights, allowing you to have a say in key decisions.

Equity payments  come with risks as well. There is no guarantee the company's value will increase, and you can  end up with equity that is worthless when  the business struggles or fails. Equity often comes with vesting periods, meaning you must remain employed for a certain length of time to receive the shares. When you leave before fully vesting, you may forfeit some or all the equity. Equity is  difficult to sell or convert to cash as well. Private company stock has limited liquidity until there is an acquisition or IPO.

You must assess the benefits and drawbacks as an employee based on your finances and risk tolerance. Equity can be part of a remuneration package, but you must be realistic about the risks and rewards.

When  the company does well, equity payments can  significantly impact your net worth and financial future in an incredibly positive way. But there are no guarantees of success, so make sure any equity offered is appropriate for your personal investment strategy.

Conclusion

Speak to your manager about learning more details and getting the full picture before accepting. Ask questions such as :