Employee Equity Compensation: A Comprehensive Guide

March 11, 2024

employee equity compensation

It’s safe to say the power dynamic between employers and employees has shifted.

Gone are the days when workers were content with salary, wages, and a small, year-end cash bonus. Employees now question the full spectrum of what companies have to offer. 

The answer to this is total reward philosophy, wherein companies consider all elements of compensation: benefits, incentives, and culture. And equity compensation has become a vital component.

The employee equity compensation approach has evolved over the years, with United States corporations and startups leading the way. Emerging trends of high attrition and remote work have reshaped the corporate and startup work landscapes.

What used to be an exclusive perk for top executives has transformed into a must-have tool for attracting and retaining talent globally across all levels of an organization.

Equity compensation as a key strategy in attracting and retaining talent

Remote work globally expanded opportunities for workers and companies, yet top-tier local talent remains scarce in many jurisdictions.

Churn is high in many emerging markets, especially the tech sector, with engineers notably not thinking twice about pursuing new external opportunities to maximize their pay potential in the short term. This makes perfect sense, given the demand for their skillset.

How have companies been able to tackle this challenge?

They’ve used equity as a useful weapon in the war for talent. As firms grow and create shareholder value, employees benefit directly, thanks to their equity interest. This win-win model creates a virtuous cycle that boosts motivation and clears the way for greater performance and long-term retention.

Why would a company offer equity to their employees?

Offering equity to employees is associated with several benefits.

Employee motivation 

Equity holders perform better at their jobs.

As companies become more valuable thanks to their workers’ strong growth and performance, the same employees benefit because they hold a claim to the company. A blueprint for a symbiotic relationship for everyone involved.

Employee retention

Rather than receive full benefits immediately, employees earn equity over time via vesting schedules, receiving their full ownership stakes only after years of continued service. This provides a compelling reason to keep top talent engaged for the long haul.

Higher value for shareholders

Employees with equity stakes share the same interests as company investors and leadership. This unified perspective focuses efforts and decision-making across the organization toward mutually beneficial goals rather than competing priorities.

As talent expectations evolve, companies now compete with each other, offering compelling equity packages to stand out.

What are the different types of equity compensation? 

The type of equity instrument employees hold as part of their company’s equity award matters crucially.

The vesting conditions are set upfront and measured at the end of the vesting period. If employees meet the terms, employees earn awards; if not, they lose out on all or some of them.

What is it they lose out on? The main types include:


Options are financial tools that give the holder the right, but not the obligation, to buy an underlying asset at a predetermined price, known as the strike, exercise, or grant price. 

Early-stage, unlisted startups commonly use them to incentivize employees.

An option is not a share, but rather a right to acquire shares in future. The value of an option is determined by several factors, like the current stock price, the strike price, the time to expiration, and the expected volatility of the underlying asset.

Simplified example: You receive 100 options at a strike price of $1. On the vesting date, if the share price is $3 you are sitting on a potential gain of $200, and you can now exercise your options at any point before the expiry.

That means you pay 100 * $1 = $100 to receive $300 worth of shares. If the share price is below $1, say $0.75, you’re out of luck as your options are underwater.

There is no point in exercising your right to receive the shares because why would you pay $1 for something that is only worth $0.75?

Options around the world

Option plan designs vary depending on location. In the United States, employees have incentive stock options (ISOs) and non-qualified stock options (NSO/NQs), as well as the ability to exercise their options before the vesting date.

UK employers offer a company share option plan (CSOP), and Australian companies provide options according to local employee share schemes (ESS) start-up concessions. The concept of the strike price still applies. However, the tax implications and potential restrictions vary, as does the decision for which strike price to use.

To note: depending on plan design and local tax and regulatory restrictions, the strike price can be set at:

  • Nil: Zero exercise price options or ZEPO 
  • Nominal: For example, $0.01 
  • A discount-to-fair market value: Below current share price 
  • Current share price: At the money options 

Local laws may even put it well above the current share price, known as the premium-priced option.

In the United States, companies don’t have as much freedom because the exercise price must be set at or above fair market value in line with Section 409A requirements.

Companies need to do their homework before deciding to roll out an option plan for their employees across borders.

Restricted stock units (RSUs) 

The easiest way to understand RSUs, also known as share rights, is to consider them as zero exercise price options. Employees who are granted RSUs receive a right to a share without needing to pay the option cost.

RSUs in the United States are automatically converted into stock upon vesting. In other parts of the world, like Australia, businesses can set up rights so they’re either automatically converted into shares upon vesting or so employees can choose when to convert them. This is how they treat options, effectively making them the ZEPOs we discussed earlier.

RSUs are considered a safer alternative to options with strike prices for employees because they retain at least some value for workers, even if the share price drops over time.

Some companies even offer employee compensation choices to anyone between receiving equity in either options or rights. In cases like this, employees generally receive three times as many options as RSUs.

If they’re eligible for an equity award, the amount granted is usually a 3:1 ratio, meaning they can receive three times as many options as RSUs. When deciding between options and RSUs, employees need to determine what’s best for their circumstances.

They have to consider if they’re both willing and able to take on more risk.

Simplified example: You receive 100 RSUs. The price on the day is $1. On vesting date, your RSUs automatically convert into 100 shares.

Your holding is worth whatever the current share price is. Even if the price falls from $1, your holding is worth something.

Performance stock units (PSUs) 

PSUs, or performing rights, are a form of equity compensation similar to RSUs. The main difference is that vesting  PSUs is based on the achievement of specific performance goals within a predetermined period rather than just the passage of time.

These performance goals can be tied to individual or company-wide targets, such as revenue, earnings per share, or total shareholder return. They’re designed to align employee interest with company performance, incentivize high achievement, and motivate key talent.

Simplified example: You receive 100 PSUs. You earn them after three years as long as you are still employed and have met your performance conditions.

When the measurement date comes, the 100 PSUs are all yours. If you haven’t met the conditions, you receive nothing, and your PSUs lapse.

Phantom plans

Phantom plans, also known as cash-settled awards, grant synthetic or “phantom,” shares or options to employees.

Phantom plans track the value of the company's actual stock without giving them actual ownership. These plans are often used when offering equity to employees is too difficult due to strict local regulations or unfriendly tax regimes – in countries like the Philippines, Vietnam, China, and until 2024, Germany.

Unfriendly tax regimes are those that create additional hurdles for companies to roll out equity incentive programs.

Employees with phantom plans ultimately receive a cash payment equivalent to the value of shares they would have otherwise received, but they don’t get actual shares. A common type of cash-settled phantom unit is called a share/stock appreciation right (SAR). The decision to cash-settle awards is usually up to the company's board, not the employee.

Tandem SARs are a type of award that combines a standard SAR with an equity instrument, like an option, giving employees a choice between cash or equity.

In short, phantom plans are cash-settled awards that allow employees to participate in the upside of the company's stock appreciation without receiving actual shares. These plans are a flexible compensation tool for companies operating in countries with strict equity regulations.

They can help avoid shareholder dilution but in turn, have an impact on the company’s cash balances, triggering more complicated accounting treatment.

Simplified example: You receive 100 phantom units that mimic an option plan. The price on the day is $1, which serves as a strike price for your phantom units. On vesting date, the share price is $3.

Your phantom units are automatically exercised by the company and you receive a cash payment of $200. At no point in time do you receive shares in the company.

Accounting and valuation considerations

Any equity compensation design decisions made by leadership or reward teams impact all functions of the company.

When companies grant equity to employees, finance teams need to consider the financial reporting obligations that arise. As we’ve said, different accounting standards exist around the world, and there are variations between equity-settled versus cash-settled plans.

Key accounting and valuation considerations for equity compensation include:

  • ASC 718 and IFRS 2: These accounting standards dictate that companies expense the cost of share-based payment awards.
  • Fair value measurement: To figure out how much expense needs to be booked in a company’s profit and loss statement, companies must determine the fair value of equity awards for expense amortization purposes. This can be complex, especially for private companies.
  • Valuation methods: Taking the current share price is not sufficient to measure fair value, and often, financial models like Black-Scholes-Merton, Binomial, or Monte Carlo simulations are required.
  • Disclosures: Accounting standards for equity compensation vary across countries and frequently dictate the information the company has to disclose in its financial statements. This is in addition to the expense booked in the current reporting period.
  • Equity vs. cash: The fair value of equity-settled awards is measured on the grant date and doesn’t change over the course of the vesting period. However, for cash-settled awards (where employees receive cash instead of shares), the value of that liability can change over time based on the company's stock price movements. 
    This value has to be re-measured at the end of each reporting period to track the ultimate liability of the eventual cash payment. These requirements for valuing and accounting for different types of share-based compensation are mandated by accounting standards.

Understanding tax implications for employees

Companies have to painstakingly consider taxes and equity awards. Implications can change drastically based on instrument types and local tax legislation.

It’s common for equity awards to be subject to income tax.

Transacting employee securities can also lead to a capital gain or loss in some circumstances. In fact, a single award can trigger either or both income and capital gains taxes throughout its lifecycle.

For example, employees often have to pay income tax when they receive the shares at the time of exercise but may also need to pay capital gains tax when they sell those shares at a later date.

If employees end up holding shares and the company pays dividends, they may also be subject to tax on dividends received as a shareholders.

The multitude of possible taxing points makes things pretty messy. Add to this that companies have to figure out when employees need to pay certain taxes, their appropriate rate, and any discounts or concessions. No one can deny that it’s complicated.

When are employees required to pay taxes after accepting equity awards?

The logical answer here would seem to be “when the employee sells their shares or receives a cash settlement.” And that is true in a lot of cases. However, the taxing point may be triggered as early as the grant date.

Early taxing sometimes happens with restricted share plans (often referred to as RS or RSA) wherein employees initially receive actual shares that are subject to certain restrictions. In the United States, employees have ability to make an election to pay tax upfront instead of deferring it until later date via 83(b) election.

The majority of equity schemes fall under rules that let employees put off the taxing point trigger until a future date. That means that employees generally don’t pay taxes when they receive their company’s equity awards on the grant date.

However, they will likely need to pay income tax on the value of that award in the future.

Are all plans taxed the same?


Two of the same underlying instruments in the same jurisdiction can be taxed differently. Options in the United States are not all treated the same; this comes down to whether the plan design is considered to be tax qualified. This means that the plan is designed to take advantage of the preferential treatment allowed under US tax legislation.

US stock options can be classified as either incentive stock options (ISOs) or non-qualified stock options (NQs, NQSOs, or NSOs). If the option issued to US-based employees meets certain criteria, workers have an opportunity to benefit from long-term capital gains tax when they transact on their ISOs after a required period of time.

What are cash-settled awards?

For employees who participate in cash-settled plans, income tax obligation generally triggers when they receive the cash payment and it’s treated just like any other cash bonus for tax purposes.

Employer obligations

Employees must be diligent and prepared to take care of their personal tax liabilities, governments everywhere do put some responsibility on the shoulders of the employers.

Leadership in many countries has an obligation to withhold taxes from employee equity transactions and/or report transactions that trigger taxing points to the local tax authority. Employers may also be required to provide employees with a year-end tax statement with the summary and calculations of the data reported.

The rules differ across borders.

Equity tax complexity makes employer assistance crucial. Companies would be prudent to invest in resources to educate and support employees on tax implications and optimal planning before and after key events like vesting or exercises.

Liquidity opportunities for employees with equity compensation

Liquidity refers to how easy it is for any individual or entity to convert an asset or security into cash. The textbook definition also points out that besides the ease of conversion, liquid assets and securities can be transacted without a significant impact on their price.

The more liquid an asset is, the easier it is for the holder to cash it out. Illiquid assets, on the other hand, are not so easy to sell. So, are employee equity awards liquid or illiquid? It depends.

Listed companies

Employees who hold equity in a listed company have highly liquid awards, as their shares can be easily traded on exchanges. However, they have to abide by the plan rules and the company's securities trading policy before transacting.

Private companies

In the case of unlisted startups, the lack of liquidity in the private markets can make it difficult for employees to cash out.

However, several types of transactions can provide liquidity for workers in private companies.

  • Cash settlement: This process involves converting equity into cash without delivering the underlying securities. Employees receive a cash payment for the value calculated as the difference between the current share price and the option cost (if any).
  • Company share buyback: Here, the employer buys back the employee's equity and acquires their awards, generally right after conversion into underlying shares.
  • Secondary transactions: These involve a third party acquiring the employee's shares, with the funds for the sale going to the employee. The company's role is limited to facilitating these liquidity programs in the private markets.

How can startup employees cash out their awards?

Employees can ultimately cash out their awards through various liquidity events, such as initial public offerings (IPOs), mergers and acquisitions (M&As), or secondary transactions.

These events allow shareholders to convert their illiquid equity into cash.

When and how can unlisted companies facilitate liquidity?

Unlisted companies can offer employee liquidity programs, which do exactly what their name says: facilitate liquidity for employees. Programs like these may take the form of a company repurchase or private tender offer.

They provide employees with the opportunity to sell their private equity options during a liquidity event, giving them more opportunities for financial benefits and flexibility.

Unlisted companies can also work with authorized brokerage firms to help stockholders find liquidity for their equity through secondary programs.

The importance of employee communication and education

Given the complex nature of equity compensation, misinformation spreads easily. It takes time for companies to grasp all the rules necessary for designing and rolling out their equity programs.

Their employees in turn often don’t have access to the support of external advisers or experts.

Unfortunately, some companies decide to limit visibility for their employees and stay secretive about the company’s current thought process. Employees end up having a hard time truly understanding the value of their equity.

This is changing. There is a noticeable trend of more companies appreciating the value of transparency and clear communication with their employees. Workers are also more empowered to require updates about their share prices.

Strategizing cross-border equity plan design and implementation

As companies expand across borders and include remote workers, they need to consider various factors to ensure their equity plans meet local requirements.

Here are some key considerations and areas of impact organizations should keep in mind.

Areas of impact Key considerations
Plan design Use of tax advantaged plans in local jurisdictions and any limitations present
Taxation of employees Tax on grant, exercise and/or sale? Income, capital gains, dividend tax
Corporate tax deductions Recharge policy impact and ability to claim tax deductions
Tax withholding Does the employer have an obligation to withhold tax for employees?
Tax reporting Requirements for reporting to the authorities and employee statements
Securities law and regulatory issues Registrations, exemptions, filings, or prospectus requirements
Plan documentation and wording Wording, translations, electronic communications, acceptance requirements
Data privacy Any specific requirements for external filling or registration?
Accounting Local accounting standard for share-based payment expense amortization
Supporting your employees Education and support (e.g. tax guides, workshops, communication)

By considering these factors, companies can properly design and offer equity plans that meet local requirements and support their expansion across borders, including remote workers.

Recent trends and best practices in employee compensation and equity programs

Three trends stand out over others.

  • Equity as part of total reward: Employees now expect equity to be included in their total reward package. This shift in expectation has led companies to reevaluate their compensation strategies.
  • Global expansion plans: Companies need to design their equity programs with future expansion plans in mind. They have to consider the legal and regulatory landscape in different countries, as well as the cultural preferences of employees in various regions.
  • Employee journey from day one: To ensure all parties unlock the full potential of equity, companies need to bring employees on the journey from day one. Employers should rely on effective communication, education, and engagement strategies to help employees understand and maximize their benefits.

Employee equity compensation has seen dramatic growth in usage and importance globally in recent years as generational preferences and a tight talent market reshape employee rewards.

As equity plans scale worldwide, thoughtful communication, education, and support unlock the door for talent leaders tasked with navigating a competitive recruiting landscape.

The global equity landscape is only growing more complex as employee mobility increases.

By taking stock of equity management to determine how their programs attract and retain top talent, companies set themselves up to expand in a way that benefits everyone.

Learn more about equity financing, its advantages, and how it differs from debt financing. 

Edited by Aisha West

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Employee Equity Compensation: A Comprehensive Guide Equity compensation gives you an ownership stake in the company after meeting vesting requirements. Understanding the details helps you maximize this employee benefit. https://learn.g2.com/hubfs/employee%20equity%20compensation.jpg
Amit Majumder Amit Majumder brings 13+ years' expertise to Qapita as Head of Southeast Asia & ANZ. His deep understanding of equity compensation programs from a global perspective helps both corporations and startups advance employee ownership. Amit helps clients with equity incentive plan design, administration, valuations, and financial reporting. https://learn.g2.com/hubfs/Amit%20Majumder.jpg https://www.linkedin.com/in/amitskmajumder/

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