What Is Stock Compensation and What Are Its Different Types?
In recent years, companies have been increasingly looking for new ways to incentivize their employees.
Today, employees are increasingly awarded shares of the company or equivalent benefits with stock compensation for their contribution to the success of the business. Stock compensation helps align employees’ interests with the company’s vision.
What Is Stock Compensation?
The term stock compensation describes an employee’s entitlement to a predetermined number of shares of the company following the conclusion of a specified period of service or the accomplishment of a predetermined goal.
Stock compensation is a way for employers to reward employees through stocks, performance shares, or stock options as an alternative or supplement to paying them in cash. There are different types of stock compensation. Companies often use different types of stock compensation plans to boost employee performance, retention, and motivation.
Benefits of Stock Compensation
Stock compensation allows the employee to actively participate in the success of the company, in contrast to the majority of other forms of compensation, such as salary and bonuses, which are based on a predetermined sum.
However, employees need to fulfill specific performance and/or procedural requirements to receive such benefits. These frequently include vesting schedules or deadlines for exchanging the award for stock.
Since the majority of stock options are conditional, employees are motivated to stay in a company for longer and work more dedicatedly toward the company’s success. Employee performance is improved, and employee retention is aided by long-term employee benefits like equity remuneration.
When a company succeeds, the value of stock compensation increases, and can provide employees with a significant stake in the company’s financial success.
Types of Stock Compensation
Stock compensation programs offer employees the opportunity to own company stock, often at a discounted price.
Some types of stock compensation require employees to purchase company stock—often straight from their payroll—while others operate more like a cash bonus.
The different types of stock compensation are as follows.
1. Restricted Stock Awards (RSAs)
RSAs are used to award company stock, with certain vesting restrictions, to employees. The shares will be owned by the employees once they accept the grant and fulfill the necessary purchase price requirements.
Since the shares cannot be readily transferred or traded, RSAs are regarded as “restricted” stock, which also helps the company to stay in compliance with securities laws.
2. Stock Options
This is one of the most widely used types of stock compensation plans. This type of agreement grants the right to buy shares at specific prices within a predetermined window of time.
Companies can provide their employees the option to purchase stocks in the future at a specified exercise price, rather than simply issuing shares to them.
Options are available in two types – call options and put options. Put options offer a choice to sell the share, whereas call options give them a choice to acquire it.
3. Phantom Shares
In this type of stock compensation, companies create a legal agreement outlining the ownership of the shares being held, as opposed to giving employees actual stock. Phantom shares are essentially deferred remuneration, and the employees are granted equivalent of the company share price at the time of the grant.
Usually, senior management, directors, and other executives are eligible for this stock compensation. The conversion price is usually determined based on the market price of the actual stock at the time of execution.
4. Restricted Stock Units (RSUs)
RSUs are stock compensation given to employees and have a vesting schedule typically based on their performance. In other words, the shares are restricted and not entirely transferable until specific requirements are satisfied, such as the duration of employment, the end of the work period, specific milestones, etc.
The vesting period is the time frame during which employees gain full ownership of their shares. Employees can only get a “pro-rata” amount of equity throughout the vesting period.
5. Performance Shares
Performance shares are special shares that a company will award to executives and corporate managers if they meet specified performance criteria.
Companies offer performance shares in the form of stock options and bonuses to prioritize business activities that will increase overall productivity and shareholder value. This form of compensation is commonly given to managers who achieve specific targets, such as earnings per share (EPS) or return on equity (ROE) targets.
Stock compensation is a great way to add value to the company and its employees. It is a great tool for increasing the motivation levels of employees to work hard and help the company grow. Setting up a stock compensation plan for employees can be challenging, but considering its advantages for a startup (or an existing business) it is worth the hassle. Companies need to be well versed with different types of stock compensation plans and related restrictions and clauses to avoid legal problems. Hence, it is advisable that you consult a financial expert to get the maximum benefit out of this scheme.
trica is a great tool that you can rely on for creating an equity compensation plan for your employees or managing your cap tables for investors; we can help you find the right solutions.
Get in touch with us today to learn more about equity management, stock options pool, vesting schedules, and more.