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An equity incentive plan offers employees shares of the same company they work for in the form of supplemental compensation awarded in many ways in the U.S. This is usually awarded in the form of stocks, bonds, and warrants. These types of plans help small businesses incentivize employees with supplemental rewards that have tight budgets.

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Common Types of Equity Incentive Plans

Employers can offer their respective employees different types of equity. Equity incentive plans come in several forms, including the following:

  • Restricted Stock Awards (RSAs): These awards grant employees company stock with some kind of restrictions. Stocks follow a specified vesting schedule or even a liquidation event. So, the employees cannot sell until the shares vest.
  • Restricted Stock Units (RSUs): These units promise an employee common company stock depending on certain vesting conditions. These conditions pass a vesting period or specific time. Employees rarely have to pay for the RSUs. Yet, they do not own the shares until the end of the vesting period. RSUs usually do not include any shareholder rights or pay dividends.
  • Phantom Units: These are also called shadow equities, and they follow a company stock’s actual price movements. Then, they pay out cash instead of shares. Phantom units give employees similar kinds of benefits in the form of stock ownership without granting them company stock.
  • Incentive Stock Options (ISOs): These statutory stock options are for companies in the United States. ISOs are usually considered to be qualified awards and provide specific tax benefits to all the workers in the U.S. Employees pay no tax after receiving or exercising the grant. Yet, the associated employee pays capital gains when they sell the stock.
  • Nonqualified Stock Options (NSOs): These specific options allow all employees the right to purchase any kind of company stock at a predetermined price. NSOs are often considered to be a substitute for some cash compensation earned by employees from their employment. They also pay income tax on the difference between the stock value and the options price.
  • Stock Appreciation Rights (SARs): These rights are linked to the value of the respective company stock over a specific period. Employees can exercise their particular SARs after the vesting period. Employees do not pay any exercise price and then receive the sum of the increase in the stock value in cash payment or shares.
  • Performance Share Units (PSUs): Employers grant PSUs to all of their employees depending on the company’s performance. The number of shares received by an employee depends on key performance metrics. Moreover, it is graded with multiple vesting points relative to the company’s overall performance.

Benefits of Offering an Equity Incentive Plan to Employees

Equity incentive plans help retain, attract, and incentivize employees. That is why this plan is considered to be a valuable component to include in an employee compensation package. Their benefits include

  • Improving Talent Retention: Global talent wants comprehensive compensation packages. That is why many job candidates actively seek different types of equity incentives. Companies that offer supplemental benefits stand out to top talent. Examples include equity incentive plans. These specific plans also attract valuable talent and are a strategy for all kinds of talent retention.
  • Engaging Talent: Equity incentive plans offer company ownership to all employees. These plans also provide a workforce with company equity that is more likely to feel invested in the business, including its success.
  • Vesting Schedules: These schedules are also often linked to a particular employee’s time with a company. This also applies to the company’s performance for the equity holder to receive the full benefits of the award. Hence, these incentives often encourage a dedicated workforce to stay with the organization for the long term.
  • Helping Businesses Stay Competitive: Smaller businesses do not usually have large salary budgets. So, equity incentive plans help startups bridge the compensation gap. These incentives help companies stay ahead of the competition to recruit the best workforce anywhere with job candidates seeking comprehensive compensation and global benefits packages actively.
  • Allowing Businesses to Save Money: Employee salaries often take up the largest percentage of a company’s budget. Equity incentive plans help businesses offer employees lower wages in exchange for equity compensation to save some money. These plans also help smaller companies and startups attract quality talent. They may also get potential investors when they need time to develop eventually.
  • Increasing Employee Investment in a Company: Employees have a more significant stake in the success or failure of a business when they are invested in a company. These people are more likely to put forth the extra effort to ensure the success of the company since they may benefit when its value increases directly.
  • Reaping Tax Benefits for a Company: Equity incentive plans can always generate leveraged tax deductions over the actual cash outlay. It means an individual will be in better shape at tax time because they get a deduction when the employee recognizes an ordinary income.
  • Offering Tax Benefits for All Employees: The employees often get some favorable tax benefits in many circumstances. They can recognize income equal to the respective bargain element. It is done so that these people do not get taxed on the appreciation when it does vest.
  • Providing Tremendous Gain Opportunities for Employees : The employees of a company stand to gain much more in compensation for all kinds of equity incentives than in a standard salary. Many tech workers receive their respective compensation through equity incentives that dwarf their specific salaries.
  • Reducing Employee Turnover: Equity incentive plans can help companies reduce any kind of employee turnover. An individual may have to wait two years after they have been granted to exercise some kind of equity option. Creating a culture that values employee contributions can help retain employees. This is even though they do not want employees to stick around just to exercise their respective incentive options. The employees will feel valued when they share the company's all-over earnings with them.
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Key Terms for Equity Incentive Plans

  • Exercise Plan: The price per share at which the owner of a specific traded option is entitled to sell or buy the underlying security.
  • Grant Date: The specific date on which a stock option or equity-based award is granted to the recipient.
  • Exercise Period: The time during which an individual can buy shares at the respective strike price.
  • Clawback Provision: The clause under which the money already paid to a particular employee must be returned to an employer with a penalty.
  • Equity Pool: The total number of shares set aside or reserved by a company from which it can grant stock options or restricted stock.

Final Thoughts on Equity Incentive Plans

The task of researching and developing an equity incentive plan can be daunting and time-consuming. Yet, determining the best plan for your respective business depends on various factors. Examples include business structure, business size, finances, company goals, and talent location. Companies that want to offer equity and stock options to all foreign talent must also consider different tax obligations worldwide. They must further prepare to offer and administer different types of global equity awards compliantly. Meanwhile, employers must adhere to foreign tax laws to know how equity incentive plans impact the classification, tax filing, and reporting requirements of foreign companies.

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ContractsCounsel is not a law firm, and this post should not be considered and does not contain legal advice. To ensure the information and advice in this post are correct, sufficient, and appropriate for your situation, please consult a licensed attorney. Also, using or accessing ContractsCounsel's site does not create an attorney-client relationship between you and ContractsCounsel.

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