How to Use Equity to Incentivize Employees

July 31st, 2014 | Posted by Sarah Jones in Guest Blogs - (Comments Off on How to Use Equity to Incentivize Employees)

NVTC is inviting members and industry leaders to serve as guest bloggers, sharing insights and information on trends or business issues relevant to other members. In his latest post on the NVTC blog, Matt Rajput of CohnReznick shares his insights how to attract and retain employees through equity compensation.

Technology company executives are continually challenged with how to attract, retain, and motivate key employees. Technology start-ups, in an effort to conserve cash, are known for streamlining operations and offering employees thin compensation and benefits packages until they land on more stable financial ground.

One idea for attracting and retaining employees is to include an equity component as part of the complete compensation package.  This can be in the form of common stock, stock options, profits interests, phantom stock, and other forms of equity.

Issuing equity to employees is a great opportunity to give employees a stake in the future of the company because the value of their stock, stock options, or other equity instrument is tied to the performance and growth of the company. This concept of ownership also creates inherent advantages as employees who become owners themselves (or have the option to become owners) will work harder to improve the business, because it will drive more value to their options.

Equity compensation promotes employee retention as vesting terms or restrictions typically require employees to remain with the company for a certain period before they are fully vested in the equity. For example, an employee can be given 100 stock options, in lieu of or in addition to an annual bonus, but the options have a four year vesting term requiring the employee to vest in 25 options each year. In this circumstance, the employee would have to remain with the company for four years to fully recognize the entire value of the 100 stock options. If the employee were to leave after two years, they would only be vested in 50 stock options leaving 50 options on the table.

Equity is also a very important carrot that can be used to attract talent.  In a competitive market, the ability to offer a prospective employee a stake in the upside of the company’s growth could be a differentiator in closing the deal.  Even if the company has the ability to pay market salaries, many astute tech executives continue to look for an equity stake.

Another attractive element of this type of compensation is that it is a cost-effective way to offer employees additional compensation that may be worth a great deal of money in the future as the value of the company improves over time.

However, implementing an equity compensation plan does not come without challenges. Some employees may not want to wait a few years for a liquidity event to receive the compensation for the work that they are currently performing. Long vesting periods, tax consequences, and high exercise prices are all characteristics that make equity issuances less satisfying to employees than cash compensation. Additionally, non-public companies may have a hard time getting employees to realize the value in an equity instrument that cannot be easily turned into cash.

Despite these pitfalls, many companies, both public and private, continue to utilize various forms of equity compensation to keep their employees motivated, well-compensated, and engaged.

Matt Rajput, CPA, is an Audit Senior Manager with CohnReznick LLP and a member of the firm’s Technology Industry Practice. Working from the firm’s Tysons Corner office, Matt has eight+ years of experience servicing publicly-traded and closely-held companies in the technology sector and he routinely provides services to private equity and venture capital backed companies. Contact Matt at Follow CohnReznick’s Technology Practice on Twitter @CR_TechInd.

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