Whether it’s to ignite a shared sense of ownership, retain top employees or attract new talent, many companies have found that offering an equity compensation plan is a great way to motivate and reward their teams. If you’re thinking about setting up an equity compensation plan at your private company, here are a few steps other companies have taken to give their plans a solid start.
What is an equity compensation plan?
Let’s begin with a definition. At its core, an employee equity compensation plan is a contract that offers employees a stake in the company they work for. Employees are either awarded stock or get the right to buy a certain number of shares at a certain price for a certain period of time.
Equity compensation plans aren’t a one-size-fits-all proposition. Companies can choose from several different award types based on their equity compensation goals and objectives. Here are four of the most common awards:
- Incentive Stock Options (ISO) – These options offer employees the right to buy stock with the potential for preferential tax treatment. The downside of ISOs is that they have several time requirements that can make them a challenge to manage.
- Non-Qualified Stock Options (NSO) – These awards offer potential preferential tax treatment for employers but not for employees. However, they are simpler and easier for employees to understand.
- Restricted Stock Awards (RSA) – These full value awards are issued and outstanding at grant. Employees own the shares from the moment they’re issued. They become shareholders right away with voting and dividend rights.
- Restricted Stock Units (RSU) – These are similar to RSAs but are not outstanding at grant. Employees aren’t eligible to buy the stock until the RSUs convert to stock when vesting is complete.
Why companies offer equity compensation to employees
There are many reasons companies decide to offer equity compensation plans, but the primary motivators are: compensation, retention and hiring.
Compensation – No matter how employees are compensated with equity, the value of stock options can play an important role in a company’s total compensation package. Offering equity compensation can be especially valuable for small companies and startups because it offers employees a potential return in addition to their salaries.
Retention – Most stock options come with vesting requirements, which means employees have to stay with a company to experience the full benefit of their equity compensation awards. This is why companies often find equity compensation to be a powerful tool for retaining good employees and motivating them to help increase the value of the business.
Hiring – There’s a lot of competition for top talent and offering equity compensation awards can make a company more attractive to potential employees. It can also help attract people with an entrepreneurial mindset who are interested in making an impact and growing the company.
How companies create equity compensation plans that work
Many private companies have implemented effective equity compensation plans by ensuring the plans work for both their company and their employees. Here are five key steps they often follow:
- Establishing the plan – Working with a law firm, companies first build the basic components of the equity compensation plan:
- Stock types to be offered
- Vesting schedules
- Plan rules and restrictions
2. Creating a reserve pool – Here are some of the key things companies may consider at this stage:
- The number of shares to reserve for stock awards under the plan
- The percentage of the company’s total fully diluted value
- How it will affect dilution
3. Approving the plan – The equity compensation plan and pool typically require board approval.
4. Creating grant agreements – Companies consider where their employees are located and what global tax implications there will be if they offer them stock in the company. Global tax rules and regulations are complex and may require plan addendums for different countries.
5. Managing the plan efficiently – Once a company has established the plan with the help of their law firm, companies decide how they will manage the day to day tasks of a plan. This may include updating the cap table, exercising and processing grant agreements, terminations and calculating expenses for stock options issued. While some companies leave these tasks to their law firm, others may find this too expensive and may opt to manage these tasks on their own. They continue to consult with their law firm on the plan while choosing to manage day to day tasks internally.
Why an equity compensation management platform makes sense
In the beginning, some companies decide to manage their equity compensation plans on spreadsheets. But many find that the company outgrows that option very quickly once the business gets bigger and or expands globally. For this reason, many companies choose an equity compensation platform like Shareworks by Morgan Stanley to grow with them.
Shareworks platform editions support private companies in all stages of growth.
- Shareworks Startup Edition – Easy-to-use tools help new companies get their equity compensation plans right from the start. You can simplify workflows and create online grant agreements with ease. Companies and employees can also view and manage awards using an intuitive dashboard.
- Growth Edition and Private Enterprise Edition – Rich features support companies as they scale and grow. You can streamline plan management by accessing pre-built reports or create customized reports tailored to the needs of your company. Employees can even exercise their stock options online and automatically see tax withholding and proceeds.
- ASC 718 and stock expensing – With built-in financial reporting tools, Shareworks can help simplify your stock expensing and reporting.
- Shareholder logins – Using a secure single sign on, employees can easily access their plans anytime, anywhere. They can manage their awards and complete a variety of transactions.
- Cap table in a single place – Get instant access to all your data in one location and bring your equity compensation structure and cap table into full view.
Shareworks Equity Plan Management
Shareworks by Morgan Stanley has helped thousands of companies with the administration of their stock option and equity compensation plans. Our clients include startups, emerging companies and global public companies, such as Uber, Dropbox and Atlassian. We welcome the opportunity to show you how Shareworks can help you solve your equity plan management challenges.
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