How to Evaluate Equity Offer: Everything You Need to Know
Knowing how to evaluate equity offer is important. An equity compensation is defined as a non-cash payment that represents an ownership in the firm.3 min read
Updated November 24, 2020:
Knowing how to evaluate equity offer is important. An equity compensation is defined as a non-cash payment that represents an ownership in the firm. This can take on many forms, including performance shares, restricted stock shares, and options. An equity compensation lets employees of the firm share the profits through appreciation, and retention can be encouraged if there are any vesting requirements. This has been used by multiple public companies as well as private companies, particularly when they're startup companies.
What Is Equity Compensation?
Recently launched firms may not have the cash or want to put cash into growth initiatives to invest in them, which makes equity compensation a good option to attract high-quality employees. Tech companies in the start-up phase and companies that are more mature have traditionally used equity compensation to reward their employees.
Common Types of Equity Compensation
Companies that have equity compensation can give their employees stock options that give them a right to buy shares of the companies' stocks at a predetermined price, which is also known as the exercise price. Over time, the right to purchase can vest, which lets employees have control over this option after spending a certain amount of time working for the company. When the option vests, the right to transfer or sell the option is gained. This encourages employees to stay with the company for a while. There is often an expiration with this, however.
Employees who can purchase aren't stockholders and don't have the same rights that stockholders do. The tax consequences are different for those that are vested compared to those that aren't, so employees need to look into what tax rules apply to their situation specifically. Different types of equity compensation are available, including incentive stock options (ISOs) and non-qualified stock options (NSOs). Both of these have the option to buy shares at a later date. However, ISOs are only offered to employees and not consultants or non-employee directors.
There are certain tax advantages available with ISO options. Employees don't need to report when they get non-qualified stock options or if it becomes exercisable. Having restricted stock means a vesting period needs to be complete and can be done altogether after a specific period of time.
Vesting can also be done equally over a certain period of time or any other combination that the management may find suitable. There are some similarities with RSU, but they represent the promise of the company to pay shares based on a certain vesting schedule. This gives the company some advantages, but employees won't gain any rights of stock ownership, like voting, until the shares are issued and earned.
When you get your shares, you'll need to think about filing Section 83b Election with the Internal Revenue Service. This lets you get taxed when equity is granted to you instead of when it vests. It may save you up to thousands of dollars depending on the startup's growth prospects and your financial situation. The essential thing to know is you need to file this within 30 days of being issued equity, so you'll need to think about your tax implications right away. Performances shares will get awarded if specific measures are met.
A performance share could include the following metrics:
- Return on equity (ROE)
- Earnings per share (EPS) target
- Total return of the company's stock related to an index
Who Gets Shares in a Startup?
Shareholders for private startups tend to fall into one of the following groups - founders, investors, or employees. Founders have full control of the shares of the company in the beginning. They'll control less of them over time as they give up shares in exchange for labor or money. Capitalists have a specific number of shares in exchange for their investment. When a company starts to raise more money, they'll issue shares to their investors more often, which dilutes the shares of everyone who previously invested.
As an employee, your shares will often be vested. This means instead of getting all your shares right away, they will be doled out over a certain period of time to try to incentivize you to stay with your employer.
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