Equity Incentive Plans: What Are They and How Do You Offer Them?

Equity Incentive Plans: What Are They and How Do You Offer Them?

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Introduction

Offering equity incentives, also known as stock options, is a common feature of many startups. It allows companies to offer more competitive benefits without increasing company cash.

Companies and employees benefit from equity incentive plans. Also, employees can earn far more from equity incentives than from a salary, and companies can save money by offering lower salaries and incentivizing employee performance.

Employees who own part of the company they're working for are willing to go the extra mile to ensure success. With the current labor shortage and the era of " quiet quitting," finding and keeping motivated staff is a pain point for all businesses. Equity incentive plans can help you overcome both problems.

When you offer equity benefits for employees, you'll have an advantage over other companies in the hiring process — and the employees you hire will be more invested in your success.

What is an equity incentive plan?

An equity incentive plan gives employees a share of the company they work for as compensation. You can offer equity through various vehicles, including:

Stock options

Stock options are most commonly used in equity incentive plans. A stock option gives employees the right to buy company stock at a preset price. This price is called the exercise or strike price and is usually the fair market value when the stock option is offered. You can provide two different types of stock options:

1. Incentive stock options (ISOs)

Only employees can be offered ISOs. When you grant ISOs, your employees get favorable tax treatment. ISOs aren't taxed until the employee sells or removes their shares. There are some restrictions on ISOs that can prevent you from granting them.

  • Your employees must exercise their ISO within three months of termination.
  • You can only grant ISOs if your company is taxed as a corporation.
  • Only $100,000 of ISOs (based on the fair market value at the time of the grant) can be exercised within a calendar year.
  • If you're offering an ISO to a significant shareholder (over 10%), the ISO must have an exercise price of at least 110% of fair market value.
  • ISOs must be exercised within ten years of the grant date.
  • ISOs can only be transferred if the original recipient dies.

2. Non-qualified stock options (NSOs)

If you meet only some of the qualifications for offering ISOs or want to offer them to contractors or service providers who aren't employees, you can offer NSOs. NSOs are taxed on the difference between the exercise price and the fair market value when the option is exercised.

If your company issues NSOs, you're entitled to a deduction in the ordinary income the employee receives when they exercise the NSO.

Restricted stock awards (RSA)

An RSA is a grant of the company's stock rather than an option to buy. RSA holders immediately receive the rights of other stockholders, such as dividends and voting rights. However, RSAs are subject to a restriction period known as the vesting period.

The vesting period can be a certain amount of time or be dictated by the company's performance. The RSA may be forfeited if the employee leaves the company before the vesting period is up.

Other equity incentives

There are also other types of equity incentives that aren't as common but are still an option:

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Benefits of offering an incentive plan for you and your employees

Because employees benefit from equity incentive plans directly, these plans motivate your employees, contractors, and other service providers to help build equity in your company.

Some other benefits for you and your employees are:

Attract high-quality talent

The best and the brightest in the tech industry have faith in their abilities and believe they can contribute to the company's advancement. Often, motivated people seek out job offerings with equity plans because they think it will pay off well in the future.

Save money upfront

There is a massive tech shortage right now that's expected to grow to 85 million unfilled positions by 2030. Accordingly, skilled tech talent commands a high salary, which can significantly strain your company's finances.

Offering equity incentive packages can help you save money in upfront employee compensation. Many people are willing to take a lower salary in exchange for company equity.

Increase employee investment in your company

When your employees are invested in your company, they have a more significant stake in your success or failure. They're more likely to put forth the extra effort to ensure the company succeeds since they'll directly benefit when its value increases.

Reap tax benefits for your company

Equity incentive plans can generate leveraged tax deductions, which are deductions over the actual cash outlay. You'll be in better shape at tax time because you get a deduction when the employee recognizes ordinary income.

Offer tax benefits for your employees

Your employees also get favorable tax benefits in many circumstances. Employees can recognize income equal to the bargain element, so they don't get taxed on the appreciation when it does vest. However, that is a risk since they don't get a deduction if the stock is forfeited.

Provide tremendous gain opportunities for employees

Your employees stand to gain much more in compensation for equity incentives than in a standard salary. Many tech workers receive most of their compensation through equity incentives that dwarf their salary.

Reduce employee turnover

Offering equity incentive plans can help you reduce employee turnover. You have to wait two years after they have been granted to exercise some equity options.

While you don't want employees to stick around just to exercise their incentive options, creating a culture that values your contributions can help retain employees. Your employees will feel valued when you share the company's earnings with them.

Gain a competitive advantage globally

While equity incentive plans are common for U.S. tech workers, many companies need to offer equity for international employees because of the complexities involved. If you offer equity to your global team, you'll stand out and be able to attract the best talent.

Making equity incentive plans global

While offering an equity incentive plan has many benefits for both companies and employees, it can be complicated to set them up when you have employees from different countries. You'll need to consider many elements before you draw up an employment contract with an equity incentive option.

Appropriate approvals

The board of directors will usually need to approve all equity incentives. They'll need to approve the plan as well as the structure of compensation based on employees' roles.

Policies for fair equity incentives

It's doubtful you'll offer the same amount of equity sharing for every employee. Instead, you'll probably have a tiered system based on the employee's role. You'll also need to consider how you structure equity incentives based on location.

You have several options based on your company's philosophy. You may offer everyone in a specific role the same equity compensation package or base it on the country's cost of living. Both models have advantages and disadvantages. Either can work as long as your company is transparent about its policies.

Securities compliance

If your company is in the United States, you may need to file paperwork with the Securities and Exchange Commission. You'll also need to comply with the laws and regulations in your employees' home countries if you plan to offer international equity incentives.

Taxable events

Different countries have different rules about tax treatment, withholding, and reporting regarding equity compensation. Keeping track of the regulations in each country can be burdensome for your HR team.

Next steps in offering global equity incentive plans

If you're interested in offering equity incentive plans to your domestic and international employees, Skuad can simplify the process. We can help ensure you grant equity to all of your employees in the most efficient manner. Treating your employees fairly regardless of location will build your reputation and make it easier to recruit top tech talent.

Hiring employees in other countries can be expensive and time-consuming if you set up your entity and HR team in each country. Working with a partner like Skuad can reduce your expenses and pave the way for you to hire international talent and offer equity incentive plans faster.

Skuad provides global employment solutions for hiring and managing international tech talent. You can hire the best talent from around the world because your geographic location no longer limits you. With the global talent shortage and the rising salaries of tech professionals, businesses that aren't willing to look at all their options will lose their competitive advantage.

With Skuad, you'll have access to an end-to-end global employment platform that allows you to easily hire, manage, and compensate employees and contractors from over 160 countries without setting up subsidiaries or an entity.

Reach out today for a demo to discover how Skuad can help you grow your international business.

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