When negotiating executive equity compensation, weighing several key factors helps ensure you offer a package that aligns with your key employees’ career goals and financial objectives. Equity compensation is often a significant component of an executive’s overall pay and offers the potential to benefit from the company’s growth and success. However, creating an appropriate equity plan for your personnel requires a comprehensive understanding of the different aspects involved.
Types of equity compensation
This outline assumes your business is a corporation. If you are a limited liability company, the structures available for an equity plan will differ. Each structure has distinct characteristics, benefits and tax implications:
- Stock options allow executives to purchase corporate stock at a predetermined price, potentially yielding profits if the stock price rises.
- RSUs are restricted units given to an executive after meeting certain conditions, typically involving a vesting period.
- Performance shares can be actual or phantom equity and are based on the achievement of specific company or personal goals.
Understanding these differences is crucial for making informed decisions that maximize financial benefits.
Vesting schedules and conditions
Another vital consideration is the vesting schedule, which dictates when an executive can access their equity compensation. Vesting can be time-based, performance-based or a combination of both. Time-based vesting means equity becomes available after a set period, while performance-based vesting ties equity access to achieving specific objectives. Vesting structures would be both realistic and designed to promote employee longevity and long-term career plans. Additionally, understanding how vesting schedules impact the timing of tax obligations is essential to avoid creating unexpected tax liabilities.
Tax implications
Equity compensation can have significant tax consequences, varying depending on the equity type. All US employees must consider federal income tax consequences and most states also impose state income taxes that may apply. The market requires employers to offer terms that minimize their employees; tax burden. These may involve strategic timing for exercising stock options or offering RSU’s to take advantage of favorable tax treatments.
Exit strategies and company policies
Employees should consider what restrictions or forfeiture provisions to impose on an employee who leaves the company. Some agreements include provisions that affect equity rights upon departure or termination. It is essential to craft these clauses carefully, especially those related to forfeiture or acceleration of vesting. Understanding these terms can protect the value of equity compensation in the future and clarify what to expect in different scenarios.
Motivate your key employees to stay
Negotiating an equity compensation package is about more than just understanding numbers. It involves thoroughly reviewing and negotiating the terms to ensure they align with company goals and market forces. By working with an attorney with experience negotiating and structuring employment agreements, employers can better structure a compensation package that supports their long-term success and financial well-being.