The Truth About Equity Compensation and What Employees Really Think

These days, it seems like every tech startup is offering equity compensation to attract the best talent. Stock options, restricted stock units — you name it. While the promise of potentially huge payoffs down the road is exciting and appealing, do employees really understand the pros and cons of these compensation programs? Equity compensation is still a mystery to most people.

What Is Equity Compensation and Why Do Companies Offer It?

Companies offer equity compensation to attract top talent. For employees, having equity means they can be part of the company's growth and make money when the company performs well. Equity compensation can be in different forms, like stock options, restricted stocks, performance shares, and more.

For companies, equity compensation is a way to motivate and keep valued employees. Employees who are also shareholders tend to feel more invested in the company’s success and growth. Equity is also a valuable employee benefit that can be very rewarding. Many employees have been able to build wealth through equity compensation, especially at startups.

However, equity compensation does come with risks for employees. Share prices can go down, stock options can end up worthless, and there’s always a possibility of a company not doing well or even going out of business. Employees must also pay a part of their earnings as taxes. As such, it's crucial for employees to know about the potential drawbacks and the positive outcomes that can happen.

Common Types of Equity Compensation Plans

Equity compensation plans offer employees the opportunity to own shares of company stock. There are a few common types of equity compensation plans companies offer:

Stock Options

Stock options let employees buy company stock at a fixed price for a specific time. Usually, the price is exactly what the stock costs when they get the options. This means employees can buy the stock at a certain price point, even if it's worth a lot later.

To make sure employees stick around, stock options become fully theirs over a few years. After that, employees can buy shares or make a profit using their stock options.

Restricted Stock Units (RSUs)

Restricted stock units represent shares of company stock that employees receive at no cost. RSUs also usually vest over a few years. Once vested, they can sell them for more money if the share price has gone up.

RSUs are a bit different from stock options. With RSUs, employees get the shares for sure, even if the stock price is low. But the chance to make a larger profit is not as high because there's no set price to buy them.

Performance Shares

Performance shares provide company stock based on whether the company achieves certain performance goals, like revenue or profit targets. Employees receive shares initially, but they must wait to see if they meet the performance standards.

Once they exceed the goals, they can get more shares than expected. But when they perform poorly, they may get fewer or no shares at all. Performance shares align employees' pay with the company's goals.

Employee Stock Purchase Plans

Employee stock purchase plans enable employees to buy company shares at a lower price, often 15% less than the normal cost. This discounted price makes it easier for employees to buy and invest in the company.

In a nutshell, equity compensation benefits both employees and the company. It gives employees the chance to own part of the company and helps employers attract and keep valued talent. One important thing is that employees must be familiar with the pros and cons of equity pay before picking a plan.

With the right info and talking, these plans can be a cool way to make sure the company and employees are on the same page.

Perceptions of Equity Compensation Among Employees

Employees often have mixed feelings about equity compensation. The possibility of big payouts may be appealing, but the uncertainty around equity compensation can be stressful and confusing.

Lack of Understanding

Many employees do not fully understand how equity compensation works. They may not grasp important details like vesting schedules, dilution, and the difference between stock options, restricted stock, and stock appreciation rights. This lack of clarity fuels misconceptions and anxiety.

To address this, companies must invest in educating employees about their equity compensation plans. They need to clearly communicate the basics, walk through examples, and give people opportunities to ask questions. Annual refresher trainings are also a good idea.

Risk Avoidant

Some employees like to play it safe and avoid risks. They prefer the certainty of cash compensation over potentially risky equity. They see equity as a gamble that may or may not pay off. For these individuals, a mix of cash and equity may feel most balanced. Companies should be considerate of different risk tolerances among staff.

Lack of Control

Employees often feel they have little control over whether their equity will be worth anything. The value depends on the company's performance and financial success over time. This lack of control and dependence on external factors that are outside of one's influence can be frustrating. The key is showing employees how their work and efforts affect the company's progress.

With open communication, education, and an understanding of different perspectives, companies can help address common concerns and perceptions about equity compensation. The result will be a workforce that feels more engaged, motivated, and invested in the organization's success.

Common Concerns Employees Have About Equity Compensation

Employees who receive equity compensation often have understandable concerns about what it really means for them. While equity can be very valuable, it also comes with risks and downsides that companies don’t always appropriately explain.

Vesting schedules can be complicated.

Employees typically must wait for their equity to “vest” or become theirs to keep. This may take 3-4 years. If an employee leaves their job before this time, they don't get to keep the shares that haven't fully become theirs yet.

Understanding all the rules about this, like cliffs, early vesting, and exit provisions, can be tricky. Many employees want companies to make these rules simpler and to tell them more clearly what will happen.

Equity compensation may be worthless if a company struggles.

Owning shares in a newly established or privately held company comes with a fair con, as you may end up losing or not gaining any profit once the business doesn’t do well or if the stock value declines. Because of this uncertainty, some employees like getting a steady paycheck instead of having shares.

Taxes on equity can be high.

You usually need to pay taxes when your equity becomes fully yours or when you sell it. The tax liability, especially on a large payout, can be an unwelcome surprise. Equity compensation often pushes employees into higher tax brackets they weren’t expecting. Some argue companies should offer tax advantaged equity and guidance on tax planning to offset this issue.

Limited liquidity until an exit.

In many cases, employees can't turn their shares in a private company into cash until something like a big sale or company takeover happens. This makes it hard for them to use the money their shares are worth, and they must wait until a special event takes place. If employees are expecting to get a lot of their pay from these shares, this waiting and uncertainty can be frustrating.

In summary, equity compensation offers advantages to employees and companies, but it also brings risks and downsides. There are complications, risks, and drawbacks that companies need to think about and explain to their employees clearly. With openness, education, and fair programs, companies can make equity work better for their employees in the long run.

Tips for Improving Employee Satisfaction with Equity Plans

Offering equity compensation is a fantastic way for businesses to draw in and keep top individuals. But for employees to genuinely profit from these programs, they must understand and value them. Here are some tips for improving employee satisfaction with equity compensation programs:

Educate employees on the plans.

Employees can't value what they don't understand. Take the time to thoroughly educate them on the types of equity plans offered. Inform them about how stock options work and the potential benefits.

Host information sessions, provide written materials, and give employees opportunities to ask questions. Explaining the tax implications, timelines for vesting and exercising options, and the company’s philosophy behind the plans will lead to greater understanding and appreciation.

Be transparent about the value and potential.

Share independent evaluations of the company’s equity with employees so they know the potential current value and possible future growth of their shares or stock options. While equity may not be worth much today, demonstrating the company’s progress and growth story can help employees see its possible future value. Transparency builds trust in the plans and the company’s direction.

Offer decision-making support.

Employees may feel overwhelmed when deciding about equity compensation and when to use it. Offer resources to help them make financial decisions. Financial advisors can be a big help. Employees will value the guidance and support they receive.

Celebrate milestones.

Publicly celebrate key milestones, such as when the first employees become vested in their equity plans or when equity values reach notable thresholds. Sharing achievements and victories lifts spirits and reminds every one of the potential rewards. Employees see that the plans can truly pay off, even if it takes time.

Consider equity refreshers.

For long-term employees who have vested all or most of their initial equity grants, consider providing new grants of additional shares or options. This shows the company still values them and lets them benefit from the ongoing work. Refreshers keep employees motivated and engaged with the company's equity plans and success.

Conclusion

Employees desire a sense of belonging within the organization. Attractive benefits and pay plans are important, but equity compensation inspires them to contribute to the company's success by giving them a feeling of ownership. Compensation strategies may differ from one company to another. But the goal is to provide a competitive compensation package to employees. Equity compensation may not suit everyone, but it adds value to your pay. When done right, it can benefit both employees and the company.

The truth is, employees highly value equity when it's offered with transparency and when companies try to educate them on how it works. Equity in compensation programs may seem complicated, but companies should be smart enough to invest in helping their people understand the options. When employees feel invested in the company's growth, it creates a win-win situation for both the business and the people who drive its success every day.