What equity compensation is about. Its pros and cons

Attracting and compensating key employees can be a challenging task for a startup. Money, especially in the first months or years of the business, may not be readily available and will be probably best invested in research and/or development of new products or services.

 

Nowadays many entrepreneurs choose to attract and retain talent by offering some form of equity compensation in addition to a monetary one. Such approach entails pros and cons for both employers and employee.

 

The good side of the equity-based compensation is that it allows startups to convince experienced and talented professionals to come on board and/or incentivize employees to continue working with the company to achieve certain milestones. By combining equity compensation with monetary an employer saves money in high salaries and bonuses. For the employee, it is an opportunity to become a partner in the company or to have the right of purchasing the stock at a fixed price in a company that may become public or sold at a higher price in the future.

 

The above-referenced pros bring immediately several cons. The employer saves financial resources, but sees the equity of his company being diluted. For the employee, the reliance on the same company for the employment and growth of his investment may not be the best strategy. If a company fails, a person will loose both. Also the fact that he won’t be receiving immediate (or even certain) remuneration that could be obtained with a more traditional employer may make such offer simply unaffordable for many.

 

No matter what form of equity compensation is selected, it often triggers complex legal and tax issues. The consequences of noncompliance with the law and tax code in structuring compensation plans can undermine the intended benefits of the equity award. The key issues in equity compensation, applicable tax rules, and other relevant laws are reviewed in other articles on this site.

 

The employers should carefully compare various available forms of equity compensation with the assistance of an experienced business attorney to determine which one would be the most beneficial for the company and attractive for the potential employees. All options have to be weighted by taking into consideration several issues, including, but not limited to, tax implications, intended vesting time, forms of payment, maximum exercise period, exercise amount, and other.

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