Tips for Small Business Owners Offering Equity Compensation to Employees

Every small business owner has considered offering equity compensation for the future of their organization. However, many things need to be considered before you do.

Financial support becomes crucial as your business matures, and it’s probably never too early to think about how you will finance future growth. One way for new founders to get investment is by contemplating equity as part of their plan from day one. You need to assess the best options to offer stocks, and understand the risks when granting stock options.

When it comes to equity compensation, there are some things that you should remember before offering it.

Why Offer Equity Compensation to Employees?

Employees are often motivated by the opportunity to earn equity in their company. Equity is a form of compensation awarded to employees through stock options, restricted stock, or other forms of equity, like preferred shares, contributed surplus, and more, that gives them a stake in the company.

With a sense of ownership, employees would want to work hard and help the company grow because they feel their growth is directly linked to the company’s growth.

Companies should only offer equity compensation after considering how it will fit into their culture and affect other benefits like salary and bonuses.

How to Offer Equity Compensation Effectively

Here are a few key things to consider as a small business owner before offering equity compensation.

1. Consider the Tax Implications

The tax implications of equity compensation depend on the type of equity, the type of company, and the length of time the employee has been with the company.

The key is understanding the difference between a stock option and a restricted stock unit (RSU). A stock option gives an employee the right to purchase shares in a company at a predetermined price. (RSUs are shares granted to an employee but do not have any voting rights or dividends attached.)

2. Budget Wisely

As a small business owner, it is important to be wise with your budget. When you offer employees equity compensation, you give them an ownership stake in the company. So if the company does well, and the stock price goes up, they will make more money than they would have without the equity compensation. But if the company does poorly and its stock price goes down, they will lose money too.

The key is to ensure that you are compensating your employees fairly for their work and not going into debt by offering equity compensation.

3. Decide How Much Equity to Offer

Consider how much equity you want to offer and how much ownership you want your employees to have in the company. This will be based on the type of equity you’re offering, which can be either common or preferred stock or a combination of both.

4. Consider the Vesting Schedule

It is worth considering the vesting schedule before offering equity compensation. Understanding the difference between a cliff and a graded vesting schedule is essential. For example, a cliff vesting schedule means that all of the equity vests  in the third year. However, with graded vestings, equity only vests at the end of each year.

For an employee to have any ownership of the company, they must complete the duration of the vesting schedule. A vesting schedule is a predetermined amount of time an individual has until they can sell their company shares. It’s important because it ensures that the company can’t be sold without the consent of all its employees.

5. Decide the Terms of the Agreement

A share option plan is an agreement between an employer and an employee where the former offers the latter the opportunity to purchase a certain number of shares in the company at a predetermined price.

The terms of the agreement can vary from company to company. Some companies sell shares to employees at a discounted price, while others offer them for free. The equity plan should also include a share option agreement that outlines all the details of what happens when an employee leaves or is fired from the company.

6. Determine Who Gets What Share

One of the first things to do is to create a share option plan that will be fair for everyone. Some of the factors that you need to consider when determining who gets what share are:

1. The length of service
2. The position held in the company
3. The contributions made by the individual
4. The time spent on training

7. Consult a Professional

Offering equity compensation can take time for startups or established companies. But, if done correctly, it can be an effective way to incentivize and attract new talent. Before offering equity compensation, the first thing to do is consult with an attorney or accountant specializing in this field. They will be able to advise you on the best way to offer equity compensation, which will save you time and money in the long run.

Final Thoughts

Offering share options is a great way to incentivize and retain employees. It can be a win-win situation for both parties as the company gets more skilled employees, and the employee receives some financial security. When employees feel like they are making an impact on their company and are included in decision-making, they are more likely to feel satisfied with their work.

Equity can be managed and transferred more easily with the help of free equity management software. trica dedicates its services to providing companies with software solutions that efficiently handle their options and help employees track their stocks. Visit trica.co for more information!