Let’s dive into a topic that many find mystifying: equity compensation. The idea of owning a piece of a high-growth company is not just exciting but laden with possibilities. We often hear stories about early founders turning stock options into fortunes, but for most of us, navigating equity is like walking through a maze filled with complex terms and conditions.

Join me as we unravel the intricacies of equity compensation. Whether you’re deciphering your first offer letter with stock options or trying to understand the stock grants mentioned in your performance reviews, it’s essential to grasp what equity compensation is—and what it isn’t. I’ll guide you through the jargon of stock options and grants, vesting schedules, and the strategic decisions between public and private company stocks.

As a tech professional who has navigated these waters personally, I understand how daunting it can feel. It’s important to remember that it’s perfectly okay to seek help and clarification from your HR or legal team to better understand the specifics of your situation. Let’s empower ourselves with knowledge and demystify the complexities together.

Stock Options Vs Stock Grants

This was the hardest concept for me to decipher in conversations around equity.  What is the difference between a stock grant and a stock option? 

A stock grant provides the recipient with value—the corporate stock. Stock grants act as a form of compensation for employees.  They are worth something the moment they’re given. A potential drawback is when awarded stocks, the employees would have to pay tax on theses stocks the same year they were issued.

By contrast, stock options only offer employees the opportunity to purchase something of value.

Stock options give the employee the right but not the obligation to buy a set amount of the company’s stocks at a set price within a specified time frame. They are a form of investment in the company.  In contrast to the grants, they can quickly become worthless if the company’s share price falls more than expected.

Deeper Dive into Stock Options

So now that you’ve deciphered if you’re being offered a grant or options, now you need to unlock the type of options they’re offering.  There are three major types of employee stock options — incentive stock options (ISOs), non-qualified stock options (NSOs) and restricted stock units (RSUs). The big difference between ISOs, NSOs and RSUs is around how you acquire them, and how they’re taxed — you purchase ISOs and NSOs, and you earn RSUs outright. All three types of stock options are taxed upon exercise, and taxed again when you sell them.

“Stock options provide employees with the right to purchase company shares at a predetermined price (exercise price) after a vesting period. Until exercised, employees do not have actual ownership of the shares. In contrast, RSUs represent a promise to grant employees a specific number of shares after vesting. Once vested, employees receive the shares outright, becoming immediate shareholders without the need to make any additional purchases.” according to Matt Secrist, Partner at Taft Law.

So, with RSUs, when your vesting period is over, you will own those stocks outright and have the right to sell. 

Understanding your vesting timeline

A vesting schedule shows when you’ll earn your options or shares. It is typically detailed in your option grant (e.g. 1,000 options over four years). The most common type used for tech companies seems to be time based using a vesting cliff.  Cliff vesting is when the first portion of your option grant vests on a specific date and the remaining options gradually vest each month or quarter afterward.

Example of a Vesting Schedule with a Cliff:

Imagine you are granted 1,000 stock options when you join a tech company. Your options come with a four-year vesting schedule with a one-year cliff. This means:

• At the end of the first year (the cliff): You earn 25% of your options. In this case, that would be 250 options.
• After the cliff: The remaining 750 options are vested monthly over the next 36 months. This equates to about 20.83 options vesting each month.
• By the end of the fourth year: You would have fully vested all 1,000 options.

This vesting structure ensures that employees stay with the company for a significant period before they can fully benefit from their equity, aligning employee and company interests. In my experience, such opportunities have often been offered when my companies underwent major transformations. These changes brought about a degree of uncertainty, and the organization used these equity grants as a strategy to retain key personnel like myself and others during these transitional periods.

Public Vs Private Stock

So now you understand grants vs options, and hopefully the vesting period.  If you’re working for a public company and you vest there are two things you can do, sell or hold them.  To sell you can use any number of platforms like E-Trade, Morgan Stanley, or whatever platform your company is using.

What happens if the company is a privately held company?  Typically, employees must wait until their company goes public or gets acquired before they can sell their private stocks.  Selling your private company stock can be tedious and expensive. Not only does the issuing company often have to approve the sale and buyer, but you may also have to hire an accountant and attorney to review your taxes and analyze your shareholder agreement and sales contracts.  Holding stock in these companies may be the best and easiest way to see value. 

Taxation is real- have your accountant on speed dial.

No matter what type of stock you own, you will have to pay taxes.  Like the American saying goes, there are two sureties in life: death and taxes.  Understanding tax implications is way outside my realm and that of a any tech leader in your organization.  I recommend talking to your accountant prior to selling stock so you understand what necessary actions need to be taken.  During my research I found some really handy tax guides from Fidelity by stock type (RSU, ISOs, etc).  I’m not endorsing their products, services or otherwise but I did find the guides to be helpful. 

HR and Finance – Your Trusted Allies in the Fight

Navigating the realm of equity compensation is undoubtedly a complex endeavor. However, armed with knowledge and empowered by curiosity, we can understand the intricacies and make informed decisions. Remember, HR and Finance departments are invaluable allies in this journey; don’t hesitate to seek their guidance and expertise. Whether you’re an employee evaluating a job offer or a leader tasked with understanding compensation options for your team, open dialogue and proactive inquiry are key. The process of offering stock is supposed to be a highly anticipate part of the process but understanding what’s being offered is key. 

References:

How to value stock options: https://secfi.com/learn/how-to-value-stock-options-in-a-job-offer-letter
What is a stock grant: https://www.oysterhr.com/glossary/stock-grant
Stock options vs RSU: Which one is right for your startup? https://www.cakeequity.com/guides/stock-options-vs-rsu
Selling Private Stock: https://carta.com/blog/selling-private-company-stock/
How stock compensation and stock purchase plans are taxed: https://www.fidelity.com/go/stock-plan-services/understanding-taxes