What Is Stock Compensation?
Let me explain stock compensation directly: it's how corporations reward you as an employee with stock options instead of just cash. If you're holding these options, you need to check if they're vested, meaning they'll keep their full value even if you leave the company. Remember, taxes on this depend on the stock's fair market value, and if withholding applies, you'll pay that in cash, no matter if your compensation came as equity.
Key Takeaways
- Stock compensation means companies give you stock or options instead of cash rewards.
- It's usually tied to a vesting period before you can collect and sell it.
- Vesting often lasts three to four years, starting after your first year of eligibility.
- Main types are non-qualified stock options (NSOs) and incentive stock options (ISOs).
- Some firms award performance shares to leaders if metrics like EPS or ROE are hit.
How Stock Compensation Works
You see, startups often turn to stock compensation because they lack the cash for competitive salaries. This way, you as an executive or staff member can share in the company's growth and profits. But there are rules to follow: fiduciary duties, tax treatments, deductibility, registration, and expense charges all come into play.
When it vests, the company lets you buy a set number of shares at a fixed price. Vesting might happen on a specific date or gradually—monthly, quarterly, or yearly. It could tie to company or personal performance goals, or just time served, or both. Expect three to four years total, often kicking off after your first anniversary of eligibility. Once vested, you can exercise the option anytime before it expires.
Example of Stock Compensation
Here's a straightforward example: suppose you're granted the right to buy 2,000 shares at $20 each. It vests 30% yearly over three years, with a five-year term. You pay $20 per share to buy, no matter the market price, anytime in those five years.
Types of Stock Compensation
You'll encounter various types, like non-qualified stock options (NSOs) and incentive stock options (ISOs). ISOs are employee-only—no directors or consultants—and they come with tax perks. For NSOs, you pay income tax on the difference between grant price and exercise price.
Then there are stock appreciation rights (SARs), which pay out the value of set shares in cash or stock. Phantom stock gives you a future cash bonus matching a number of shares' value. Employee stock purchase plans (ESPPs) allow you to buy shares at a discount.
Restricted Stock
With restricted stock and restricted stock units (RSUs), you get shares after years of service and hitting performance targets, either by purchase or as a gift. Restricted stock demands a full vesting period, which could be all at once after time passes, or spread evenly over years, or whatever setup management chooses.
RSUs are close, but they're the company's promise to deliver shares on a vesting schedule. This benefits the company, but you don't get ownership rights like voting until the shares are actually issued and earned.
Performance Shares
Performance shares go to executives and managers only if specific targets are met, like hitting an EPS goal, ROE, or stock return compared to an index. These usually span multiple years.
Exercising Stock Options
To exercise options, you might pay cash, swap owned shares, do a same-day sale via a broker, or a sell-to-cover deal. But companies often limit you to one or two methods. Private firms, for instance, restrict selling shares until going public or being acquired, and they don't allow sell-to-cover or same-day sales.
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