A stock based compensation plan allows the employee to gamble on the success of a company without having to give up any cash upfront. Companies typically grant options and RSUs to new employees with their first job offer. The options or RSUs are usually vested in five years. If the employee is successful, the company can increase the value of the company’s stock, increasing his or her money when they sell their stake. However, it’s important to understand the risks and benefits of stock based compensation before making the decision.
The most common form of stock based compensation is restricted stock awards, restricted stock units, nonqualified stock options, and incentive stock options. Each of these types of compensation has its advantages and disadvantages with regard to taxation. The table below shows the tax consequences of these different types of stock-based compensation. If you’re planning to award stock options to employees, make sure that you’ve carefully considered the tax implications of each type of stock-based compensation.
The main disadvantage of stock-based compensation is that it can dilute existing shares and reduce the value of existing ones. Therefore, stock-based compensation is a good way to cut costs and improve profitability in the short-term, but it’s also risky for companies with poor financial performance. However, stock-based compensation can be exceptionally lucrative for the employee over the long-term.
While share based compensation is a permanent fixture of the corporate world, the benefits and risks are complex and often confusing. Before embarking on a stock-based compensation plan, make sure you do your research and consult with a professional advisor. There are many benefits to stock-based compensation, but be sure to keep these things in mind to ensure that you get the most out of your investment. If you choose to take the plunge, you may be pleasantly surprised with the potential financial returns.
If you plan on offering stock options to your employees, you will need to determine the right time to vest the awards. Most companies will opt to vest stock options after a certain period of time (typically three or four years). If an employee leaves the company before the vesting period, the company forfeits the shares. However, if they stay, the shares are theirs for life.
There are also some potential tax benefits associated with stock based compensation. Employees may be able to deduct the value of their stock, but the amount they receive will depend on how the stock is valued. Stock options can also be used to attract and retain employees, so make sure you know your tax implications before you start giving out employee stock.
Another advantage of stock-based compensation is that it requires no capital to exercise. Employees are usually not exposed to market risk until they actually buy the stock.