Giving employees access to equity compensation as part of their overall rewards package has proven beneficial for companies, both private and public, the world-over. Whether you’re looking to remain competitive in the hiring process or seeking ways to motivate, reward and retain existing staff, the addition of equity awards can make a big difference to employees
There is no one-size-fits-all solution however, as certain plan types might not meet your needs, may not be available in the regions you are operating in, might not be suitable for your company type or a variety of other reasons.
With that in mind here’s a quick overview of some of the more common forms of equity compensation and their defining characteristics.
Employee Stock Purchase Plan (ESPP)
- Allows participating employees to purchase company stock at a discounted price.
- Designed to be an all-employees plan.
- Two types of ESPP: A qualified plan adheres to the IRS Section 423 regulations, whereas a non-qualified plan does not.
- More flexibility in how a non-qualified plan can be designed, but qualified ESPPs receive more favorable tax treatment.
- Used throughout the world, but companies need to make themselves aware of local regulations before introducing an ESPP outside the US.
Read more about ESPP>>
Growth shares
- Stock-based incentives designed to allow specific individuals to benefit from the future growth of the company.
- Align the interests of employees with those of shareholders.
- Typically aligned to specific individual performance and/or company milestones.
- Tends to be used by UK-based companies, but can be offered to US-based employees.
- Local tax rules apply.
Read more about Growth Shares>>
Performance awards
- Allocations of stock which vest if specific company goals are achieved.
- Often used to incentivize management to drive the business forward.
- Performance stock awards (PSAs) are granted prior to vesting, but are not actually delivered until the vesting conditions have been met.
- Performance stock units (PSUs) represent a promise made by the company to specific individuals to award them stock at the point when vesting conditions have been met.
- PSAs and PSUs are treated differently for taxation purposes, e.g., Section 83(b) election is available for PSAs.
Read more about PSUs>>
Phantom shares
- Employees receive the financial benefits of stock ownership without a) receiving company stock or b) being required to make a financial investment.
- Track the value of a company’s actual stock.
- Typically paid out in cash, in line with a vesting schedule.
- When compliant with Section 409A rules, no tax becomes due until the compensation is received by an employee, when it is treated as ordinary income.
- Tax rules outside the US may differ depending upon the jurisdiction.
Read more about Phantom Shares>>
Restricted stock
- Gives employees a stake in the company.
- Shares have no actual value until they vest (waiting period or when a milestone is reached).
- Two distinct types: Restricted stock awards (RSAs) and Restricted stock units (RSUs).
- RSAs: Shares are granted at the outset.
- RSU: No shares change hands until vesting.
- RSAs are eligible for a Section 83(b) election, meaning they receive more favorable tax treatment.
Read more about Restricted Stock>>
Stock appreciation rights (SARs)
- Linked to the company’s stock price over a defined period of time.
- Granted at a set price and vest over time.
- Differ from Stock Options as employees do not pay an exercise price, instead receiving the difference between the value at the outset and at exercise, either as a cash payment or in shares, assuming the FMV has increased over time.
- No tax due until exercise.
- Gain is treated as ordinary income.
- Any additional profit made if selling stock later is taxed as either a short- or long-term capital gain.
- Tax rules outside the US may differ depending upon the jurisdiction.
Read more about SARs>>
Stock options
- Give individuals the right to buy a specified number of company shares for an agreed price – usually, the fair market value (FMV) when the agreement is made – at a future date.
- The hope is that FMV will increase over time. Employees profit when exercising their options at the earlier (lower) price.
- Two main types: Incentive stock options (ISOs) and Non-qualified stock options (NSOs).
- Fewer restrictions attached to NSOs, but ISOs receive more favorable tax treatment.
- Can be offered globally.
- Companies should inform themselves on the regulatory rules in different countries.
- Depending upon the jurisdiction, stock options will be taxed at one or more of four distinct moments: grant, vesting, exercise, and sale.
Read more about stock options>>
What next?
Having a clear idea of what your company’s goals are and understanding your audience are key factors to consider when reviewing what plan type or types might best suit your needs.
At J.P. Morgan Workplace Solutions we have worked with companies all around the world for many years in preparing and developing employee equity compensation plans. If you would like to find out more then get in touch.
Please Note: This publication contains general information only and J.P. Morgan Workplace Solutions is not, through this article, issuing any advice, be it legal, financial, tax-related, business-related, professional or other. J.P. Morgan Workplace Solutions’ Insights is not a substitute for professional advice and should not be used as such. J.P. Morgan Workplace Solutions does not assume any liability for reliance on the information provided herein.
