Why should companies have an employee equity incentive plan?

An equity incentive plan is a business-approved program that establishes regulations that apply to a contract between a company and an individual to give the individual with interest in or tied to the company’s shares. The individual could be a firm employee, director, advisor, or consultant.

An equity incentive plan aims to incentivize this personnel by increasing the company’s value as a result of their future performance. For smaller companies, providing an equity incentive plan incentive employees to stay longer and be more committed to helping grow the company. Which also has the impact of motivating key employees to stay with the company.

In this article, we will share what an employee equity incentive plan is, how both parties can benefit from it, and why companies should ultimately provide an employee equity incentive plan.

What is an Employee Equity Incentive Plan?

A long-form agreement with each individual or a set of scheme regulations for all participants with a short-form grant agreement with each individual can be used to implement an equity incentive plan. The company awards the participant an option under an employee share option plan, which allows the participant the opportunity to exercise the option to purchase shares in the company at a predetermined price during an exercise period. Options often vest in accordance with a vesting schedule.

The Pros and Cons

A lot of advantages exist with an employee stock option plan. The vesting schedule is designed to incentivize participants to stay with the organization for the term of the vesting schedule. This aids in employee retention. Key personnel’s interests will be linked with those of the company since key personnel stands to benefit directly from future increases in the value of the business.

Employee stock option arrangements present difficulties. It is difficult to determine the market value of a private company’s shares. This has an impact on both determining the grant allocation to each important employee and determining the grant exercise price. If options are exercised, and participants are issued shares, the corporation should also examine how it will manage its capitalization table. A large number of stockholders places an administrative load on the company.

Share options should normally be provided in relation to non-voting shares in order to avoid diluting control or voting rights. If employees leave the company, the company must determine how to handle options and shares issued upon exercise.

Types of Equity Incentive Plans

There are 3 different types of equity incentive plans that companies may look into getting for their company. They are:

Restricted stock, restricted stock units, and performance shares

When you are issued restricted stock, you receive a pure grant of business stock, but you cannot hold it until all of the limits have expired. Upon vesting, you will receive the complete market value of your company’s equity, and the restricted stock units can be redeemed for cash rather than stock.

This method works well for high positions executives such as the CEO of the company. CEO of Tesla, Elon Musk, just recently announced his compensation goal of $23 billion for growing Tesla. These incentives allow him to work harder to achieve compensation equity.

ESOP (Employment stock options purchase)

Employee stock options provide businesses’ employees with the right, but not the obligation, to buy or sell a stock at a predetermined price and date. Employees can buy a fixed number of business shares at a defined price after a particular time period, which is known as the exercise price.

Employees must comply with all the business conditions imposed during the vesting period to exercise stock options. Once the vesting period is over, the corporation enables a repurchase scheme where employees can cash in their ESOPs and gain money.

Phantom Stocks

Phantom Stocks, sometimes known as Shadow Stocks, are an employee benefit plan that provides certain benefits to largely senior firm employees without requiring ownership of shares. Even though they are fictitious equities, phantom stocks track the price movement of a company’s genuine shares, which may result in profits during distributions. Phantom stocks are great holding assets for employees as they provide employees with dividend income.

Why providing an incentive plan benefits both you and prospective employees?

Now that you understand the pros and cons of having an employee equity incentive plan on paper. You will now hear why an employee equity incentive plan would help boost business morale.

The company saves equity

Salaries are one of the most expensive expenses that businesses confront. Salaries can account for 40% to 80% of a company’s operational budget, depending on the industry. Stock incentive plans enable businesses to save money by offering reduced compensation in exchange for equity. While employees still receive a monthly paycheck, they may accept lower pay because they value owning equity in the company.

With more equity in the business, the company will be able to use this free cash flow to invest more into the business. Whether it is to invest in new equipment or tech or hire new manpower to accelerate the growth of the business.

Employee turnover is reduced

Employee equity incentive plans are susceptible to vesting timetables or stock ownership timeframes. Depending on the parameters of the vesting schedule, an employee may have to stay with the company for three to six years to receive the full benefits. This motivates employees to stay and advance with the company. With longer retention of employees, businesses do not have to spend the time to retrain new staff and are more able to focus on the company’s mission and growth.

Able to Recruit talent that is in for the mission

We have seen many great company successes by hiring talent solely interested in accomplishing the company’s goal. Job seekers typically look for jobs that interest them, with a clear mission statement and reward system for accomplishing these missions.

For example, Tesla hosted a “Tesla AI day” recruitment event on September 30, 2022 to recruit talent and tech experts in AI. By sharing more about what the company is looking to build in the next 5 years and how they are able to support the employee. More talents would come and support Tesla.

How businesses need to evolve and start providing Employee equity incentive plans?

Equity incentive pay can be especially advantageous to early-stage firms that may lack the capital to compensate and retain their staff. Furthermore, equity incentive schemes serve as a resource to attract and keep a strong workforce for startups in order to attract potential investors.

Need Help?

By offering equity-based plans as employee compensation, startups may attract top personnel and grow more quickly. The startup’s founder must understand these schemes’ tax and regulatory complexity. You must grasp the various employee compensation plans and how they might help you. Get Eqvista to handle your company’s equity and stock management.