Equity Compensation

aka "What is this other stuff I'm being paid with?"

Equity compensation (or “equity comp” as we like to say, to try and sound more cool) is more common than you might think. The most famous type is probably stock options for senior executives, but they are just one out of many kinds of equity comp (see how ultracool I am?) that are out there.

Here's a short list of examples: Stock Options (NSOs and ISOs), ESOPs, ESPPs, RSUs (last set of initials, I promise!), Phantom Stock (spooooky), Grants, and so on.

If one or more of those look familiar to you, you might have equity compensation.

Ok, so what is it?

In short, it's when you get paid to some degree in stock of the company you work for. Usually the point is for you to get the stock at a lower share price and then you can someday, hopefully, sell it at a higher one and reap the rewards. Sometimes you're being given the stock directly, sometimes you're given the chance to buy it at a possible discount, but whatever the details, the point is that you might get to cash it in for a profit.

Of course, as with any investment, you might not. Or even lose out. The company could go bankrupt, the stock might never have value, all sorts of things can go wrong.

But the hope is for your potential shares to skyrocket in value. The classic example is a startup company that doesn't have a lot of money and so part of how it pays those early employees is in shares of stock. Then the company makes it big, goes public on a stock exchange, and those shares are now worth a lot of money.

Famously, the guy hired in 2005 by Facebook to paint murals in its offices was paid in stock options. In 2012, when the company went public, those options were worth about $200 million!1

Of course, most people with equity compensation don't get $200 million out of the deal, but it can certainly be profitable.

A Really Big Shoe: Taxes

If the risk of loss of value is a potential shoe to drop, the other shoe is taxes. All too often, especially for those who have equity compensation but no financial or tax advisor to guide them, this is the shoe that clobbers you. That list of some example types of equity comp from earlier? Each one of them has its own rules for how the taxes work and it can get pretty complicated.

Depending on the type you're dealing with, there might be rules based on factors such as:

  • The date you were granted the equity compensation
  • The date the compensation vests
  • The date you exercise an option in the compensation
  • The date you sell the underlying stock
  • How much time you wait between some of those actions (yup, that can matter).

That's a lot of potential for tax mishaps and possibly higher tax bills as a result. So it's really important to understand how your particular equity compensation works and what the tax implications may be. A highly qualified tax advisor is going to be worth their weight in gold here, you should definitely talk to one if you are granted equity.

Overall investment picture

Right along with the tax side of things, there's the important task of figuring out how this investment (remember, owning stock means you own an investment) might fit into your overall financial planning and investments. If you wind up with a bunch of shares of company stock, how much of your overall portfolio does that one company now represent? Should it represent that much? It's not uncommon to find that equity comp leads someone to have too many of their investment eggs in that one basket and if that's not addressed, they could run into some serious problems.

Imagine, for example, having a lot of your net worth in your company's stock and then the company runs into problems that cause the share price to plummet. This is actually a double whammy to cope with. One, a lot of your net worth just took a plunge down. And two, the company you work at is apparently having some kind of problem. What if that impacts your actual job because of layoffs or raise freezes or the like? The company becomes a single point of failure for both your regular wage income AND your investment portfolio. That is probably worth looking into to see if that risk could and should be reduced.

Ok, so now what?

All right, so I've outlined some of the pitfalls and complexities involved, where do you go from here? First off, congratulations on having some equity comp in your life! All the mechanical rules can make it easy to lose sight that it's pretty cool to be offered this sort of compensation and you should definitely enjoy that feeling of pride and success.

Then, celebratory cake consumed, it's time to do a little legwork. Grab your paperwork and actually read it. Because the good news is that you probably don't need to know how all types of equity comp work, just the type(s) that apply to you. So find out what you have, in the paperwork they had to provide you when the grant happened, and suddenly this all becomes a lot more manageable.

Once you know what you have, you can research how it works. Maybe on your own, maybe with a tax or financial advisor. Either way, you want to feel comfortable and knowledgeable about the choices that you might have to make and what they mean. With a little due diligence, advice, and mindfulness, you should be in good shape to make the best decisions for you and your family.

And definitely enjoy the cake, you earned it!