Securities Fraud Lawyer Explains: Equity Compensation is Not Just for CEOs Anymore
Equity compensation, also known as a stock award, is a form of non-cash compensation that represents ownership in a company. If the company does well and the value of its stock goes up, the future value of the stock award could be higher than if the employee was given cash today. Equity compensation is one way for a company to attract or retain talent without having to pay out large salaries.
The popularity of equity compensation for rank-and-file employees, especially among cash-strapped start-up companies, is on the rise. According to a study done in 2010 by the National Center for Employee Ownership, 28 million employees in the U.S. owned stock or stock options in their companies. The most common types of equity compensation are stock options and restricted stock units (RSUs).
An employee stock option (ESO) is a contract that gives the employee the right to buy a certain number of shares in his or her company at a predetermined price (exercise price) after a specific date. Typically, an employee must use his or her own money to exercise the option and buy the stock. ESOs do not have any marketable value since they do not trade in a secondary market and they are generally non-transferable.
An RSU is a unit of stock in the company that the employee possesses with limited ownership rights. Generally, the employee will receive any dividend equivalents for the RSUs, but cannot sell the RSUs until a specific condition is met or until after a certain vesting period (many companies use RSUs that vest over a certain period of time as an incentive to retain employees). RSUs do not require any cash outlay by the employee to own the stock. Once the specified condition is fulfilled (e.g. the specific performance goal has been met) or the vesting period is over, the ownership restrictions will be extinguished and the employee will own the stock outright.
Both ESOs and RSUs have tax implications. RSUs are taxed upon vesting. The tax treatment of ESOs depends on whether they are “qualified” or “non-qualified” options. You should consult a tax professional to determine the tax implications of your specific equity compensation.