Equity Compensation 101: When and Why Employers Pay in Equity

Earning in cash is so last century. Many companies are now offering equity compensation as part of the employee benefits package. Are you curious why they pay employees in stocks instead of cash? Read on and discover why employers choose to pay in equity.

What Is Equity Compensation?

Some companies are offering payment in equity instead of the usual paycheck. This is what we call equity compensation. Instead of regular cash payment, employers pay employees with stocks or stock options.

Equity compensation involves giving employees shares of stock in the company or the option to buy shares at a lower price. When the company's stock price goes up over time, those shares and options become more valuable. It is a move to make employees part owners, tying their success to the company's. The better the company performs, the more their equity is worth. This approach aligns with employee and company goals.

For employees, equity compensation can be very lucrative when the company grows substantially in value. Of course, risks exist as the stock price can decline, in which case the options or shares may be worthless. Equity comp is a gamble that can pay off big or yield nothing. But for ambitious companies and talented employees, it is a risk worth taking.

Types of Equity Compensation

Equity compensation is when employees get company shares instead of cash as part of their pay.

There are two main types of equity compensation:

• Stock options: Employees have the option to buy company stock at a discount for a set period. When the share price goes up, employees can buy at a lower price and sell at a profit. Stock options usually have a vesting period to encourage employee retention.
• Restricted stock units (RSUs): Employees receive company shares that vest over the time they stay with the company. RSUs provide more guaranteed value than stock options. Employees can sell their stocks once vested.

Equity compensation motivates, retains, and attracts talented employees by aligning their interests with shareholder interests. When done right, it a win-win for companies and key employees.

Why Companies Offer Equity Compensation

Traditional paychecks may seem easier to manage. But why do some employers opt for paying in equity? Companies offer to pay in equity for several reasons.

1. Equity compensation gives employees ownership of the company. This aligns with the interests of employees and shareholders. When the company does well, the employees benefit. This can motivate employees to work harder to help the company succeed.
2. Equity compensation is a way for companies to attract and keep top talent. Some candidates find the chance to own a part of the company and share in its success appealing. Equity pay gives them the chance to earn from the company's growth and success over the long run.
3. Offering equity is beneficial for companies because it conserves cash. Rather than paying higher salaries, companies can offer stock options and RSUs. This cuts costs, saving capital for business growth. Equity compensation ties employee pay to company performance, giving them more stake in the game. This inspires employees to make decisions that maximize shareholder value.
4. Startups with not enough cash find equity compensation a good option. New companies frequently cannot match the salaries of more established firms. Equity compensation allows startups to compete for the best candidates while conserving resources to build the business. Employees get the opportunity to earn significant wealth when the company succeeds. This mutually beneficial arrangement helps startups attract talent and pursue ambitious growth plans.

Companies offer equity compensation to benefit both the company and the employees. When structured properly, equity compensation becomes a win-win for both.

Pros and Cons of Pay in Equity

As good as it sounds, paying in equity can have a potential downside. Here are some pros and cons of equity pay:

PROS

• Offering equity gives employees a sense of ownership and a stake in the company’s success. This can increase motivation and align the interests of employees with the interests of the company and its shareholders. Employees may work harder and be more invested in the company’s growth and performance.
• Equity compensation is a good way for startups or small companies with limited cash to attract top talent. The promise of potentially large equity gains can lure skilled employees. Stock options and restricted stock units are popular forms of equity pay for this purpose.

CONS

• For the company, equity pay means giving up ownership and control. When the company struggles or goes out of business, the equity may end up worthless, failing to properly compensate employees for their work.
• For employees, equity pay means taking on risk. There is no guarantee of a payout, and employees can end up with nothing. Equity pay comes with vesting schedules as well, so employees must remain with the company for a certain period before gaining full ownership of the equity. This can reduce job mobility.
• Equity pay may lead to resentment when some employees gain much more from equity payouts than others. And equity payouts are taxed, sometimes at high rates. Employees must pay income and capital gains taxes on any equity compensation they receive.

Equity pay is a solid way to align company and employee interests, promising shared success from the get-go. But watch out for risks. For many startups and growing companies, it is a compensation package staple, but not for everyone.

Situations Favoring Pay in Equity

The benefits of offering to pay in equity sound good. But timing is essential as well. Equity compensation comes in handy for certain types of companies and roles.

Early-stage startups

Startups or small businesses with limited cash flow often pay employees with equity. In the early stages, equity is a smart way to attract top talent who believe in the company's mission and growth potential. Pay in equity lets employees own a piece of the company, which becomes valuable when the company succeeds. This move helps the company save cash while getting skilled individuals on board.

Equity pay is common in sales and business development roles, especially in startups. Offering a share in the company's success motivates them to bring in new clients and close deals.

Long-term Project Commitments

For projects with an extended timeline, choosing to pay in equity is a strategic choice. It aligns the interests of the participants with the project's success over the long haul.

Limited Cash-Flow

Some companies experience limited budgets or tight finances from time to time. In challenging times or economic uncertainties, offering equity is a strategic move. It allows companies to conserve cash for essentials while attracting valuable team members.

While equity pay comes with risks, especially at an early-stage company, it can be very rewarding. When the company succeeds, employees share in that success.

Conclusion

Equity pay seems a complicated at first, but it can be good for both employers and employees when used smartly. Familiarizing yourself with the basics will help you assess whether it is suitable for your situation. While not suitable for everyone, equity pay is gaining popularity for attracting and keeping talent. Find an approach that makes sense for your circumstances by educating yourself on the pros, cons, and structures. This will set you on the right path to determine whether equity pay is a win-win for your career or hiring decision.

Are you unsure how to pay your employees? Check out Salary.com and the wide range of products and services they offer to help you with your compensation decisions.