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What to Know Before Negotiating Equity Compensation

What to Know Before Negotiating Equity Compensation

April 10, 2023

Companies often use equity compensation, such as stock options, to attract and reward talented employees. As an employee, it’s essential to understand the types of equity compensation available to you and how they may affect your financial situation.

Employee stock options require clout, especially for public companies. Usually, only the senior-most executives or key employees are granted stock options. In addition, the higher up the corporate ladder you go, the more negotiating power you will have.

What Is Equity Compensation? 

Equity compensation is a form of payment that gives employees the right (but no obligation) to own a part of the company they work for. This type of payment can come in different forms, such as:

  • Stock options: The most common type of equity compensation. These give employees the right to buy company stock at a predetermined price within a certain timeframe.
  • Restricted stock units (RSUs): RSUs are a form of equity compensation where employees receive company stock once certain conditions (like specified performance milestones) are met.
  • Restricted stock awards (RSAs): These are like RSUs but give employees the ownership rights of company stock as soon as it is granted.
  • Performance shares: Company stock given to employees as part of their annual performance bonus.

Each type of equity compensation has advantages and disadvantages that should be considered before negotiating.

Common Employees Stock Options Negotiating Tactics 

How can you negotiate the best deal possible when it comes to employee stock options? Here are a few common tactics:

Accelerated Vesting Schedule 

A vesting schedule is a timeframe in which an employee can exercise their stock options.

For example, if a company grants an employee 10,000 stock options, but they’re only allowed to exercise 2,000 each year over five years, that is their vesting schedule.

Accelerated vesting reduces the period of stock distribution. This is beneficial if you want to take advantage of a rising stock price or need the money for an emergency.

Early Exercise 

Exercise refers to the act of buying company stock with your employee options. As the name suggests, an early exercise allows you to purchase stock earlier than the original vesting schedule.

Most companies require employees to work for a certain period before exercising their stock options. However, some companies may allow early exercise if they believe employees will stay with the company long.

You get restricted stock units (RSUs) instead of stock options using this option. However, you must pay taxes on the RSUs as soon as they are granted. Therefore, carefully weigh the benefits and drawbacks before choosing this option.

Post-Termination Exercise Period 

What happens if you are terminated before your stock options vest? In some cases, employers may allow a period after termination, during which you can still exercise your stock options. This is called a post-termination exercise period.

You can negotiate for a more extended post-termination exercise period, which gives you more time to decide whether to buy company stock. However, some companies limit the time and number of shares that can be exercised.

Potential Problems in Equity Compensation 

Although equity compensation can be beneficial, there are potential downsides. First, the value of the stock can go up or down. If it goes up, you make money. But if it goes down, you lose your investment.

Second, employee stock options are often tied to company performance and may be revoked if goals aren't met.

Finally, exercising employee stock options may have tax implications. Depending on the option type and when you exercise it, you may owe money to the IRS. Therefore, it’s essential to understand all the potential risks before negotiating your equity compensation package.

It's also important to remember that no amount of negotiation will help if a company goes bankrupt or is acquired by another company. Therefore, it's essential to research the company and its financial performance before agreeing to any terms.

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