Equity Compensation: A Primer

Equity compensation is complicated - hard stop. Below I provide a brief summary of four types of stock-related compensation plans.

Given the nuances of each type of equity compensation, this article is intended to provide general information related to the various types of equity compensation most commonly utilized by companies. Links to my more in-depth articles on each specific option type are within the summary description if you want to take a deeper dive on any of these.

Restricted Stock Units/Awards:

RSUs are a form of (additional) compensation issued by a company to an employee in the form of shares of company stock. They are issued to employees through vesting and distribution schedules. Typically they are awarded for the achievement of performance milestones or upon remaining with their employer for a particular length of time. In theory, RSUs enhance employee commitment for the work they perform by giving employees interest in company stock. Once the units vest (meaning they become legally owned by the employee) they are assigned a fair market value (FMV). At vesting, they are also considered ordinary income, and usually, for the convenience of the employees, a portion of the shares are withheld and sold to pay income taxes. The employee receives the remaining shares and can sell them immediately, or later at their discretion.

Incentive Stock Options (ISOs):

ISOs are a corporate benefit giving an employee the right to buy shares of company stock at a discounted price with the added benefit of possible tax breaks on the profit. The profit on qualified ISOs is usually taxed at the capital gains rate and can vary between short-term and long-term depending on the holding period. Note: every company's plan differs in its details so it's important to consult your financial and tax advisors on the best way to utilize ISOs to build your wealth. ?

Non-Qualified Stock Options (NSOs):

NSOs are very similar to ISOs, but have an additional tax component embedded in them. With NSOs, an employee pays ordinary income tax on the difference between the grant price and the price at which you exercise the option. By means of an example

Non-qualified stock options give employees the right to buy a set number of company shares within a specified timeframe at a preset price. Sometimes NSOs are offered as an alternative form of compensation to workers and also as a means to encourage their loyalty to the company. The expectation is for the company’s share price to increase over time. This would mean the employee is potentially acquiring stock at a discount if the grant price is lower than future market prices.

Employee Stock Purchase Plan (ESPP):

ESPPs are company-run programs that allow participating employees to purchase company stock at a discounted price. Employees contribute to the plan through payroll deductions which build up between the offering date and the purchase date. Participation in the ESPP commences after the offering period has begun. The purchase date marks the end of the payroll deduction period. On the purchase date, the company uses the employee's accumulated funds to purchase company stock on behalf of the participating employees. This stock is immediately owned in-full by the employee, there is no vesting schedule.

Disclaimer: Due to the complex nature of equity compensation, you should speak with your trusted advisor to help guide you with advice specifically relevant to your individual situation. The information above is intended to be educational in nature and not provided as advice or an offer to sell securities. Investing always includes risk and past performance is not indicative of future results.