Equity Grants: Understand how to grant equity to employees

Every business leader would love the opportunity to attract and retain top talent by offering them a unique incentive: a share in the company itself. But, with the endless corporate options and competition, there is always a chance to miss out on the best means to do so. This is where equity grants come into play, a strategic approach to employee compensation that goes beyond the traditional paycheck.

Equity grants are non-cash compensation that provides employees with a percentage of ownership in the company. The primary objective of this article is to explain what equity grants are and guide employers on how it works in favor of company development.

Equity Grants in Employee Compensation

Equity grants in employee compensation are vital for startups and established companies to attract, motivate, and retain talent. Equity compensation is a powerful incentive for employees; offering them a share in the company’s future success makes them more committed and motivated to contribute to its growth.

Let’s look at what are equity grants, how they function as equity compensation, and the types of equity grants available.

What are equity grants?

Equity grants are non-monetary compensation given to employees, granting them a stake in the company. This stake can come in various forms, such as:

• stock options,
• restricted stocks
• performance shares

Companies must navigate the legal, tax, corporate, and contract implications of granting equity to employees, ensuring these plans align with the company’s goals and objectives​. This work by providing employees with ownership interests in the company, which could increase in value as the company grows.

Equity usually vests over a predetermined period, requiring employees to remain with the company for a certain time before they fully own the equity. This vesting schedule often includes a “cliff” period, after which a significant portion of the equity vests and continues to vest gradually over time​.

Types of equity grants

Equity grants are complex, with significant implications for the company and its employees, including legal, tax, and financial considerations. Each type of equity compensation has its own set of rules, especially concerning taxation and vesting conditions. Let’s discuss these types.

Stock options

These are the most common forms of equity compensation, especially in early-stage companies. Stock options give employees the right to purchase company stock at a predetermined price after a certain period. There are two main types of stock options:

• Incentive Stock Options (ISOs)
• Non-Qualified Stock Options (NSOs)

ISOs are usually more tax-advantageous for employees but can only be available for employees, not consultants or board members​.

Stock Option Example

Teak Inc. grants Jacob stock options to purchase 1,000 shares at $15 per share. The current market price is $20 per share.

• If the stock price stays above $15 by the expiry date, Jacob can exercise the option and buy the shares for $15 each, then immediately sell them for the market price (e.g., $25), making a profit of $10 per share.
• However, if the price falls below $15 before the expiry, the option becomes worthless, and Jacob loses the opportunity to buy at the discounted price.

Restricted shares

RSUs are company promises to grant a specified number of shares or a cash equivalent to an employee at a future date, upon meeting certain conditions or vesting requirements.

Unlike stock options, RSUs don’t require employees to purchase the shares; they are outright. Taxation occurs when RSUs vest as ordinary income based on the FMV of the shares at the time of vesting.

Restricted Shares Example

Teak Inc. awards Jacob 500 restricted shares of stock as part of his compensation package. These shares vest over 4 years, meaning Jacob gets ownership (and voting rights) gradually:

• Year 1: 25% of shares vest (125 shares)
• Year 2: Another 25% vest (125 shares)
• Year 3: 25% more vest (125 shares)
• Year 4: The final 25% vest (125 shares), making Jacob the full owner of all 500 shares

If Jacob leaves Teak Inc. before all shares vest, he might forfeit some or all of them depending on the terms of the grant.

Performance share

These grants link the vesting of equity to achieving specific performance targets or company metrics. Unlike the other types of equity, performance shares align the interests of employees and shareholders by directly tying compensation to company performance.

Performance Shares Example

Teak Inc. offers Jacob a performance-based incentive with 200 shares tied to achieving a specific sales target (e.g., 15% growth).

• If Teak Inc. meets the sales target, Jacob receives the 200 shares as compensation. However, he doesn’t get any shares if the target isn’t met.
• This aligns Jacob’s interests with the company’s success, motivating him to contribute towards achieving the sales goal.

Benefits of Equity Grants for Businesses and Employees

Equity grants are vital for businesses and employees, fostering a mutually beneficial relationship that encourages growth, loyalty, and shared success.

How Equity Grants Help Businesses?

Equity grants is an excellent way to share a percentage of companies shares to its employees in the form of non-cash compensations. Let’s begin by analyzing how it benefits businesses.

• Attract and Retain Top Talent – In competitive markets, offering equity compensation helps attract and retain the best talent by providing a financial stake in the company’s future success. It is especially crucial for startups and scale-ups navigating economic uncertainties where cash may be tight.
• Align Employee Interests with Shareholder Value – Employees become part-owners, deeply invested in the company’s performance by granting equity. This alignment of interests encourages employees to work towards increasing shareholder value, driving better performance and innovation​​.
• Foster a Culture of Ownership and Commitment – Equity grants create a sense of ownership among employees, encouraging a long-term commitment to the company. This ownership mentality promotes a culture where employees are more engaged and motivated to contribute to the company’s success​​.
• Reduce Reliance on Traditional Compensation Methods – Equity compensation provides a way to compensate employees without straining the company’s cash reserves. It is particularly advantageous for startups and growth-stage companies focusing on conserving cash while still offering competitive compensation packages​

How Equity Grants Helps Employees ?

Equity grants are considered as compensation that gives employees the opportunity to become stakeholders of the company. Now, it’s time to see how it benefits employees.

• Build Wealth and Share in the Company’s Success – Equity grants offer employees a chance to share in the company’s success, potentially leading to significant financial gains as the company grows.
• Increase Engagement and Motivation – Employees are likely to be more engaged and motivated with a direct stake in the company. Knowing that their efforts can directly influence the company’s value and, consequently, their financial gain, employees are encouraged to contribute their best work​​.
• Retaining Talents – Equity compensation is an excellent tool to retain talents in the company and attract new talents as well.
• Gain Exposure to Financial Markets and Investment Strategies – Participating in equity grants educates employees about equity markets and investment strategies. This knowledge can benefit personal financial planning and understanding the broader economic factors that impact the company and its stakes​​.

How to design an equity grant program?

Designing an equity compensation program involves careful planning and strategic thinking to ensure it aligns with your company’s goals and effectively motivates and rewards employees. Here’s a structured approach to creating such a program:

Understand The Purpose and Goals of Equity Grants

The first step is to clearly define what you aim to achieve with your equity compensation program. Common objectives include:

• Attracting and retaining skilled talent in a competitive market.
• Aligning employees’ interests with the long-term success of the company.
• Encouraging a culture of ownership and commitment among the workforce.
• Providing a compensation package that is both competitive and financially sustainable for the company.

Align Equity Grants With Employee Roles and Contributions

To effectively structure how equity grant works:

• Differentiate by Role – Tailor equity awards to reflect your employees’ varying roles, responsibilities, and contributions. It ensures that the grant is perceived as fair and directly correlated with the value an employee brings to the company.
• Use Various Equity Awards – Implement different types of equity awards, such as stock options, restricted stock units (RSUs), or stock appreciation rights, depending on the level of incentive you wish to provide. For example, new hires might receive initial grants as an incentive to join, while existing employees could receive promotion or performance grants as recognition for their contributions.
• Annual Review – Consider creating a new option pool each year to address the needs of new hires, promotions, and outstanding performance, ensuring that your equity compensation program remains competitive and rewarding.

Balance Equity Grants with Other Forms of Compensation

An effective equity compensation should be one component of a broader compensation strategy that includes ,Salaries,Bonuses, Benefits and other perks.

Balancing equity with these forms of compensation ensures that employees receive a well-rounded package that satisfies their immediate financial needs and offers long-term growth potential through equity.

How to determine equity grant size and vesting period?

Determining the size of and their vesting periods involves several critical considerations tailored to align with your company’s objectives and the individual’s role. Keep the following points in mind while designing your grant’s plan:

• Equity compensation is usually tiered based on the employee’s role, contribution, and potential impact on the company. For example, key executives might receive a larger percentage of equity compared to other employees.
• The standard for key employees at the executive level can range around 1.5% to 2%, but it might vary depending on the individual’s impact and negotiation outcomes.
• Benchmarking against market standards for similar roles within your industry is crucial. It helps ensure your equity offerings are competitive and can effectively attract and retain your needed talent.
• Consider how future funding rounds will dilute the equity percentages of current stakeholders, including employees. Planning for future dilution can help decide the appropriate size of grants to ensure they remain meaningful as the company grows.

Determine Vesting periods of Equity Grant?

Vesting periods incentivize employees to remain with the company and contribute to its long-term success. The following points will give you an idea of implementing the right vesting schedule:

• A common vesting schedule is over four years, with a one-year cliff, meaning the first 25% of the equity grant vest after one year, with the remainder vesting monthly or quarterly over the next three years.
• The vesting schedule should align with the company’s goals and the time frame over which employee contributions can significantly impact the company’s value.
• Consider incorporating flexibility in your equity plan to allow for accelerated vesting based on outstanding performance or critical milestones achieved by the employee or the company.
• It’s important to structure equity grants and vesting schedules in compliance with relevant securities laws and tax implications. Most equity compensation is subject to vesting restrictions, which stipulate that equity cannot be fully owned (or “vested”) by the employee until certain conditions, typically related to continued employment, are met.

How to grant equity to employees?

Let’s now discuss how you can grant your employees equities. Remember, it’s always advisable to seek help from seasoned experts.

Designing an Equity Grant Program

Clearly define what you want to achieve with your equity compensation program, such as attracting talent, Retaining employees, or Aligning employee interests with company goals. Then, choose between stock options, restricted stock units (RSUs), or other forms of equity based on what best fits your company’s strategy and employee motivation.

Determining Equity Grant Size and Vesting Period

Look at industry standards and competitor practices to determine competitive grant sizes for various roles and levels within your organization. As mentioned earlier, choose your vesting schedules wisely. Commonly, this will vest over four years with a one-year cliff. It encourages long-term commitment from employees.

Equity Grant Valuation

For private companies, 409A valuation often determines fair market value, updated at least every 12 months or after a significant event like a new funding round.

Communicating Equity Grants to Employees

Clearly explain the value of the equity being offered, how the vesting schedule works, and what happens to the equity in various scenarios like leaving the company or a sale of the company. Provide resources or sessions to help employees understand the potential financial impact of their equity compensation.

Choose Advance solutions for Equity management

Use software solutions for equity management to streamline grant administration, track vesting, and manage exercises and sales. Keep equity compensation records up-to-date and give employees regular statements about their equity status.

Align with goals and Objectives

Assess the effectiveness of your equity compensation program annually to ensure it continues to meet your objectives and remains competitive. Be prepared to adjust the program based on company performance, changes in the competitive landscape, or employee feedback.

Manage your employee equity grant on Eqvista!

Equity grants are a powerful tool for companies looking to attract, retain, and motivate employees by aligning their interests with the business’s success. Companies can leverage this to build a committed workforce by carefully designing and administering an equity compensation program efficiently.

For companies seeking assistance in managing employee equity grants, Eqvista offers a comprehensive solution. With its robust equity management platform, Eqvista helps streamline the administration of grants, ensuring accuracy and compliance throughout the process. Eqvista simplifies the complexities of equity management for businesses of all sizes. Visit Eqvista to get started.