How Do I Grant Equity to Employees?

Equity to employees gives workers a share of ownership in the company they work for. Ownership in the form of a percentage can be given in recognition of loyalty, hard work, and dedication, or as an incentive to perform.


Giving employees equity can be a great way to retain talented staff. It helps motivate them while also providing an additional layer of reward. Let’s explore the basics of employee equity and explain why it’s such a popular benefit for employers and employees alike.


What is Employee Equity?


Employee equity is a form of stock ownership given to employees by their employers. It allows them to share in the profits and losses of the company. Depending on the type, employee equity can be awarded as virtual shares or in actual shares.


Virtual shares are used to reward employees without having to issue actual shares. This can be a cost-effective alternative for companies that would rather avoid the tax and administrative paperwork that come with granting ownership while retaining control over the company, as virtual shares would not possess voting rights. A virtual share is a commitment by the company to pay bonuses that correlate to the share price or declared dividends. 


Employee stock options are options to buy actual issued shares at a pre-set price, independent of whatever the market price of the stock might be on the day the option is exercised. They are used to incentivize higher performance and usually come with a vesting period attached. Companies may also include a buyback clause that allows them to repurchase the shares at any time if they choose to terminate an employee’s employment. Restricted stock and restricted stock units are also forms of employee equity. They are shares given to employees with restrictions, such as a vesting period and a minimum number of years that need to be worked before they can claim the stock.


Benefits of Equity for Employees and Employers


Equity offers numerous compelling benefits to employees. For one, it allows employees to become owners of the companies they work for. This can provide excellent long-term incentives for high-performance workers, as a company that grows in value will raise the ownership stake of each employee. Equity can also be an effective tool to entice talented job seekers who may not be willing to take a role without some form of ownership in the company. Equity is sometimes accompanied by a reduced salary, which can provide more flexibility in tailoring a compensation package to the needs of the employee. For example, sometimes it may be better to take one’s income as salary, sometimes as dividends, sometimes as revenue from the sale of stock, etc. Stocks can also be a means for deferring income for retirement planning.


Employers also benefit significantly from offering equity as part of their compensation packages. For one, it can be an incredibly effective tool for recruiting top talent. Equity attracts job seekers who may not otherwise accept a traditional salary offer alone. Additionally, offering equity allows companies to share the rewards of their growth with the employees who helped create it. This can lead to a more loyal and motivated workforce as employees become invested in the company’s success, and are incentivized to help each other do better. Offering employees equity can reduce costs for employers as they are not paying out large salaries or bonuses. This means that companies can offer attractive compensation packages while still controlling their costs.


Granting Equity to Employees


When setting up an equity grant program it is important to ensure the program is in line with both industry standards and legal regulations. This requires researching competitive salaries, setting a vesting schedule (which determines how long employees must stay with the company before they receive their full grant), and performing a 409A valuation – an IRS-mandated assessment of your company’s finances, as well as seeking advice from a securities lawyer in your company’s jurisdiction. It is also important to plan for grants and promotions, set an expiration timeline for stock options, and decide whether employees can exercise their equity early. By understanding the basics of granting equity to employees, companies can create an effective grant program that rewards and motivates their team members while remaining competitive with industry standards.

Stock Options for Employees

Stock exchanges have a long history within America. The first was the Philadelphia Stock Exchange, originally the Board of Brokers of Philadelphia, founded in 1790 and was followed by the New York Stock Exchange two years later. For nearly as long as the United States has been a country, they have had brokers buying and selling stocks. 


Since the latter half of the 20th century, however, the idea of stock options for employees has been popular as an incentive tool for employees to have a vested interest in the company’s success. For both publicly traded and private companies, offering employees the opportunity to be awarded or purchase shares is a powerful incentive. This practice has continued into the modern-day, as grantees (the employee or executive of a company) can receive the option to buy stock in the company for a fixed price in a finite time. This process also includes a vesting period, which is a period of time that a grantee will need to wait before they can exercise their stock options.


There are two main types of stock options, Incentive stock options (ISOs) and Non-qualified stock options (NSOs). The difference between these types is that the former is usually offered to top talent and executives while being treated as capital gains when taxed, while the latter is granted to employees of all levels and considered income when taxed after being exercised. For example, as an incentive to continue excellent performance, a company can give an employee or executive the option to buy 500 shares in the company at $5. As the name indicates, this is an option that an employee is granted the right to do, but it is not an obligation. If the employee buys the stock at $5 over the period designated by the company, the employee will then have the option to sell the share after the vesting period has passed. 


Most plans for employee stock options allow a percentage of stock to be sold each year. In our example, if the company allows for 20% of the stock to be vested each year, after one year, an employee will have the ability to sell the 100 shares of their stock options, and so on for each year as the stocks continue in the vesting process. The advantage for employees granted the right to exercise stock options in the company that they are working for is that they will, in most cases, receive that stock at or lower than the market price. The purpose of this is to make an employee feel like the company’s success is tied to their success as well. If they can work to further the company’s goals and raise the price of the company’s stock on the stock market, the employee can sell their stock options and make a profit. 


Continuing our example, if the employee has $2500 in shares in the company and the market price increases, they will make the difference. So, if the company reaches $8 per share by the time the employees’ stock is fully vested, they can sell it for $4000, for a $1500 profit. 


The typical scenarios for this type of stock option are in start-up companies or as incentives to bring the best talent to a larger company. For the company, the incentive does not come from the operating budget but helps to involve employees in the company’s success. The success of the company is a success for all.