August 23, 2022
Offering equity as a startup is one of the most powerful ways to increase the value of a total rewards package — but ensuring that employees understand the full value of that equity is one of the biggest challenges.
Equity offers a share in company ownership. It’s a key part of compensation that aligns incentives of employers and employees, giving employees the potential to own and share in the company's future profits.
It’s also a great way to incentivize employees to feel more invested in the outcomes of the company — if the employee performs better, the company value may increase, which means the potential of a greater payout and greater value over time. A program with strategically placed vesting schedules also encourages employees to commit to a company for the long run.
But how do you make an equity program that works? Below, we explore progressive equity trends that are popular among employees and will make you stand out from the crowd.
Because equity is such a varied and powerful tool in compensation, employers can use equity in innovative ways to close candidates and retain high-performing employees.
Here are a few strategies your company can try out:
Consider laying out two or three different compensation scenarios in a candidate's offer package, with ranges of either more cash or more equity.
For example, an offer package may include a choice between the following:
Some private companies decide to confidentially share the company's valuation and currently valued stock price with candidates during the offer process. This helps to give candidates a baseline understanding of the offer's current value, and shows them that the company practices equity transparency.
Whether the candidate is more interested in cash or equity has to do with their:
If you offer more equity rich options, make sure to keep track of each decision. Doing so can have pay equity implications down the line if there is a disparity between different decisions.
An exercise window is a fixed period of time an employee has to exercise their options. Some companies have exercise windows as short as 90 days after an employee leaves their position. This poses a big problem for many employees: some of them simply can't afford the cash it would cost to exercise their options and pay all applicable taxes.
In effect, that means that an employee could be forced to leave a good chunk of their compensation on the table if they don't have the needed cash on hand within the exercise window. What's more, a private company could take a decade or even longer to go public (if at all). Once again, forking over all that cash almost immediately poses a big risk to employees who might not have the bandwidth to swing it.
Longer exercise windows prevent employees from going underwater with their options if they purchase them before they’re ready to. An employee who has the option to wait to exercise options once a company goes public knows that it was a safe bet to exercise.
Offering longer exercise windows for options also reassures candidates that the value of their options will last for a long time, and that they won't have to make a choice between leaving it on the table — or stay while feeling unmotivated with golden handcuffs.
Most of the time, employees can only exercise their options after their options have vested. Early exercise offers an alternative option, so that an employee can exercise their options earlier.
Typically, the biggest benefit here is saving on taxes: if an option is close to its strike price and close to expiration, this could potentially be a beneficial time for an employee to buy. Depending on the circumstances, an employee may decide to file an 83(b) election at the time of granting, instead of when the stock has vested.
However, choosing early exercise does mean the employee assumes the risk of exercising their options before they are fully vested.
Investing in equity within a private company comes with its risks, as employees may not have an immediate option to cash out on their shares. Liquidity events allow equity owners to cash out on their investment — potentially bringing a huge windfall, especially for early employees and investors.
Typical liquidity events include:
1. Convey the potential for growth
Avoid being that company that offers 10,000 stock options with no additional context.
Showing the number of options available to the candidate may come off more as abstract numbers than total value. Software that explicitly lays out the potential growth value of equity over time is a great way to educate employees on the full value of the offer, empowering them to make the best choice for their lifestyle and needs.
2. Explain equity and stock options
Many candidates do not understand the nuances of equity, much less basic concepts like vesting and exercising options. Ensuring that the candidate has a full understanding of what equity means — including the full value of that equity's potential — is pivotal when laying out different options.
Below, here is a common scenario you can copy and paste for candidates to help them understand how equity works. But first, some common terminology to get started:
When an employee signs on with a new company, they may receive stock options at a set strike price. In order to exercise their options, they typically need to wait for a certain amount of vesting time or a cliff. Once they are able to exercise their options, they can purchase the stock at the strike price they were originally offered.
For example, Preeti is a designer for a venture-backed tech startup. Preeti got in on the ground floor, so she took a lower annual salary with a higher amount of stock options.
Let's say the strike price of her options were at $0.25 a share when she started at the company. Her company is on a four-year vesting schedule, with 25% of her options vesting each year, and with a one year cliff.
That means that Preeti will have to wait one year until she can begin to exercise 25% of the options available to her at the original strike price. On year two, she can exercise 25% more (50% total), on year three, 25% more (75% total), etc.
If Preeti left the company before her one year mark, she would forfeit any rights to her stock options as she didn't meet the vesting cliff. This system incentivizes employees to stay longer in order to gain all of their vested stock.
3. Explain paying taxes on equity
Most candidates and employees don't understand the implications of taxes on equity. Let employees know that they won't have to pay any taxes on their options until they decide to exercise them.
Once they decide to do so, depending on specific laws and regulations, they may need to calculate taxes owed based on several factors:
Due to the complexity around taxation of equity and assets, it’s never a bad idea to get professional tax advice after exercising options.
When it comes down to it, creating a high-quality equity offering is not only a great recruiting tool, it's also a great retention tool. This boils down to a few elements:
Most candidates and employees never get to see — much less understand — the full value of their total rewards packages. Many companies are now turning to compensation software tools like Agora to communicate total rewards and boost employee hiring and retention.
From demystifying compensation to compelling equity offers, we’ve got you covered. Want to see how it works? Schedule a demo with our team.
Today, we’re excited to announce Agora has been acquired by Payscale, one of the leading compensation data, software, and service providers.
Agora helped Turquoise translate complicated spreadsheets and equity program details into consolidated offer letters with built in modeling tools.
Simplify your compensation practices and effectively communicate total rewards to your people.