5 Questions to Ask About Your Company's Annual Equity Plan

There's being invested in your company, and then there's being invested. Some employers offer potential employees equity in the company, in the form of stock options, as a hiring incentive. Equity means you will actually own a share of this company, and as it grows so will the value of your investment. Which is cool, of course, but dealing with annual equity isn't quite as simple as just cashing a check. 

Let's look closer.

What is an employee equity plan?

Equity basically gets broken up into steps and stages, goal markers you need to cross before you see any profit. For example, when you're hired, you may be granted the right to purchase company stock at a fair market price that will be locked in as soon as you're brought on board. As the company grows, so too does your return on any future stock you buy, since its value goes up while that set purchase price remains the same. However, that doesn't mean you can drop a bundle and buy up all the stock you can afford on day one.

Just like accruing paid days off, or other earned benefits, there are going to be restrictions as to when you can begin to exercise your equity options. Many companies require you to stay employed for a while, at least a year, before you can exercise your option (buy stock). This ensures someone is a good fit for the company, before they take any degree of ownership. Other companies set milestones you or your entire department first need to meet.

Types of equity

• Stock options. An "option" means you have the ability to purchase up a certain amount of company stock at a set value. "Vesting" means meeting the requirements set by the company before you're allowed to buy, and usually refers to the vesting period (the time before you can exercise your option). In general this means working for the company for a determined amount of time. However, options can also expire after a certain period, beyond which any stock purchases you make will be at full market value, not the discounted rate you previously had.
• Restricted stock. Much the same as a stock option, but with a few more hurdles, often including a longer vesting period. However, further restrictions (yep, it's called restricted stock for a reason), such as meeting certain departmental goals before options become available, also apply.
• Phantom stock. Stock you neither buy nor actually own. Rather, it's a kind of bonus to be paid based on a set amount of stock valued over a given time period. Receiving a payout from your phantom stock option amounts to being awarded a cash bonus, so it will be taxed. There are actually tax considerations when it comes to any kind of annual equity, so a little research on your part goes a long way toward keeping you informed of both your options and your obligations.

Equity vs Salary

• Both are a source of income, however equity is only a potential amount of income, based on a number of factors.
• Salary is directly related to your performance. You show up, you get paid.
• The value of your annual equity is based on the company's performance. As stock prices go up, so does your potential payout. If they go down? Same.
• Salary is delivered at regular, steady intervals.
• Cashing out your equity means selling your stock. You don't get paid until that happens.
• Salary is immediate.
• Equity is long term. That's why it's called an investment.

Questions to ask about your company's annual equity plan.

1. What will be my percentage of ownership?

Stocks are essentially a small ownership of the company. A clear picture of how much you'll "own" helps you evaluate the potential value of your equity over time.

2. What kind of stock options will I be receiving?

See the above breakdown for a few different kinds of stocks and option arrangements. Make sure your potential employer is able to spell out what kind of stock they offer, when you would be able to exercise your option, what the buying cap might be and any other restrictions (other than time) you might first need to meet. 

3. What about taxes?

Money from annual equity is taxable, regardless of what kind of stock you receive. You need to know what that means for you. Taxes can vary by state and industry, so get as much information as you can.

4. What is my vesting schedule?

You want to know how long you have to be with the company before you can even begin to access this incentive. Not planning on working for this company the rest of your life, or even more than a few years? Look for options that let you buy (and sell) sooner.

5. When can I sell my shares?

Because you want to know when you can get your money, right? Right.

How is equity paid out?

Counting on your annual equity paying out in any real, substantial fashion is a risk. Why? Because it's an investment, which is code for calculated gamble, and these are never guaranteed pay-offs. What you're doing when you accept employee equity is banking on the hope that this company will be successful enough down that road for you to cash in on that success. This can be an incentive for you to invest yourself into building the company, and might be offered to you for just that reason.

Some companies will offer equity-based pay, in which some of your salary will be offset by an equity percentage (either after a vesting period or right away). This is also something to consider carefully, since it will be a while before the stocks you accrue (you receive a percentage of the company's equity over a set period of time) to actually attain any kind of value for you.

Final thought

Remember that annual equity, while a nice incentive or bonus, is essentially an investment and therefore carries a certain amount of risk. Don't be swayed by what at first seems like a really sweet deal. Do your research on the company, ask questions and remember that you can always try to negotiate. Don't sign up until you know for sure you've found the offer that's best for you.

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Heather Adams is a business storyteller.