Equity Agreement
6 Kinds of Equity and Equity-Like Compensation to Learn About
Nov 11, 2024
When it comes to common forms of equity compensation, Stocks and Options are top of the list. However, as covered in our post on what to look for in Equity Agreements, the list doesn’t end there. We’ve sifted through the Offer Letters and Equity Agreements from the past year for this week’s post on all the forms of equity compensation to be aware of. For each form of equity compensation, our goal is to briefly cover what it is and key unfavorable terms to watch out for. For deep-dives, we recommend the trove of detailed information written by our Knowledge Partner, EquityFTW, as well as other trusted sources included below.
Restricted Stock Unit (RSU)
A RSU is equity that is ‘restricted’ from being fully yours until certain conditions are met. The most common condition is a vesting period, meaning you must remain at the company for a period of time before they convert to normal shares of company stock. For private companies, another condition will be the acquisition or IPO of the company. It’s worth mentioning Performance Stock Units (PSUs) in this category, as they are essentially RSUs with additional, performance-based conditions before vesting. A unfavorable term to watch out for is a service requirement that results in the loss of even your vested RSUs if you leave the company.
Restricted Stock Award (RSA)
Similar in some ways to RSUs, RSAs have two major differences that have significant tax implications (learn more here). First, you own them at the time of grant as opposed to time of vest. Second, you may have to pay to receive the granted RSAs. As a result, they are typically provided to early-stage employees when the price per share is low. Similar to RSUs, a major pitfall to look out for is a clawback term that allows companies to repurchase vested RSAs, particularly if they can repurchase at a lower price than its current market value.
Stock Options (ISOs and NSOs)
A Stock Option provides the ‘option’ to purchase stock at a preset strike price. When the market value of your company’s stock goes up, you stand to profit from the spread between your strike price and its market value. It’s worth learning about the difference between ISOs and NSOs to fully value your compensation. One major unfavorable term unique to stock options is a short Post Termination Exercise Period, which is the window of time you must exercise your options by before they expire.
Stock Appreciation Right (SAR)
Somewhat similar to Options, SARs only provide value if the price of a share increases from the time of grant. The major difference is that SARs compensate employees on the appreciation without needing to transact any actual shares. Employees are granted SARs at an initial price, and after a vesting period, they can be exercised to be awarded as either cash or shares equal to the price increase. You don’t need to pay the exercise price as you would for options. The unfavorable terms to identify would be the exercise window and the expiration of SARs, as a limited window or short expiration period can both render SARs useless.
Phantom Stock
Similar to SARs, Phantom Stock ‘simulates’ the monetary benefits of stock to employees without transacting actual stocks. Unlike SARs, they can, but don’t have to, further simulate other aspects of stock ownership, such as dividends and voting rights. Like SARs, Phantom Stock can be valued based on the increase in price over time. Unlike SARs, they can also be valued based on the full price of the stock. Unfavorable terms for Phantom Stock are limited and forced redemption, where your company has a lot of control over when the Phantom Stock can be cashed out.
Profit Interests
Profit Interests are equity-like compensation for Limited Liability Companies (LLCs), as LLCs cannot issue stock. The value of a Profit Interest is based on the appreciation of a LLC’s underlying value above an initial ‘liquidation threshold’. Profit Interest are distinct from Capital Interests, which is valued based on the total value of the LLC as opposed to just its appreciated value. A major unfavorable term of profit interests is dilution due to an automatically increasing liquidation threshold as new capital enters the company.
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While this list may seem to range from absolute basics to things you’ve never heard of, we compiled it based on submissions to Ask Ginkgo just in the last year. Chances are, you may encounter some of these kinds of equity compensation in the future. We’ve included links to trusted sources where possible, so please send us any questions you may have, especially if it’s about a type of equity compensation not included here!
For advocacy and beyond,
The Ask Ginkgo Team
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