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7 min to readWednesday, July 10, 2024

Equity Bonus: Options, Benefits, and Processes

Written by: Jeff Yoder

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Equity Bonus - Options, Benefits, and Processes

Equity bonuses can play a key role in helping companies get and keep talent, even with a limited compensation budget.

According to the US Bureau of Labor, almost 3.5 million US workers quit their jobs every month. This turnover incurs considerable costs for businesses, with the average expenses typically amounting to 6 to 9 months’ worth of an employee’s salary. High turnover rates can have a substantial financial impact on organizations and demonstrate the importance of effective retention and talent acquisition strategies.

Increasing employee loyalty and attracting top talent can be challenging for startups and other businesses that operate with limited resources and budgets. In these cases, equity bonuses can serve as valuable incentives.

Explore the benefits of equity bonuses and other forms of equity compensation, and learn how to implement these strategies into your organization to improve retention and optimize employee productivity while remaining within your budget. 

How does an equity bonus work? 

An equity bonus grants an organization’s employees shares of the company. Unlike stock options, equity bonuses are awarded as actual company shares rather than the right to purchase shares at a set price in the future.

An equity bonus can be offered to new hires as part of their compensation packages or as an incentive to motivate existing employees. At the organization’s discretion, these shares may be subject to a vesting schedule, meaning employees must fulfill certain conditions, such as working for the company for a set period, before gaining full ownership rights.

What is an equity offer in a new job? 

Organizations may offer equity bonuses as part of their compensation packages to attract high-quality talent. This is a common strategy for smaller businesses, such as startups, with limited budgets to compensate employees competitively. Candidates may be inclined to accept an equity offer in a new role as it aligns their interests with the company’s success and can potentially result in significant financial gain as the company grows.

This form of equity compensation also encourages employees to consider a long-term affiliation with the company rather than perceive it as a short-term job opportunity.

Equity bonus benefits 

Equity bonuses can aid an organization’s retention efforts while motivating employees to improve their performance and share the company’s values. The top advantages of equity bonuses include: 

Talent attraction 

Top-performing talent can be drawn into an organization offering equity bonuses due to the potential for future wealth and long-term financial gain. As a result, organizations can compete with established corporations, even with budgetary constraints, enabling them to attract talented candidates without offering higher salaries. 

This strategy will also appeal to a greater number of candidates who are interested in securing long-term positions as opposed to individuals seeking short-term roles.

Employee morale 

Equity bonuses instill a sense of ownership in employees, potentially leading to increased engagement and pride in their work. Employees will feel that their work efforts will directly impact the organization, which can result in positive outcomes regarding their company shares. 

Offering equity bonuses can also demonstrate an organization’s appreciation of an employee’s contributions, further motivating the team and boosting their morale.

Alignment of interests 

Organizations can align their interests with employees by linking their company’s growth with the employee’s financial gain. This creates a shared incentive structure where both the organization and its employees benefit from the company’s progress and achievements. 

As employees see their financial rewards tied to their company’s prosperity, they are more invested in the organization’s growth and performance, which improves motivation and collaboration.

Long-term retention 

Equity bonuses are a form of long-term incentives (LTIs) because they intend to encourage employees to stay with the company for extended periods. By implementing equity bonuses and other LTIs, organizations can increase their retention rates and reduce expenses associated with the recruitment process.

Organizations can significantly benefit from retaining employees with equity bonuses as it leads to greater stability within the workforce and supports sustained growth and profitability.

How to implement equity bonuses 

The successful implementation of equity bonuses in your organization can be achieved through a four-step process. 

1. Outline terms

Organizations must begin by outlining the terms of their equity bonus system and clearly defining eligibility criteria. 

Typically, equity bonuses are reserved for key employees, such as executives, senior managers, or top-performing individuals who contribute significantly to the company. Organizations can utilize workforce analytics software to gain data-driven insights into employee performance and compensation to assess which employees are most suitable for receiving equity bonuses. 

At this stage, a vesting schedule for the equity bonuses can also be established, as this specifies when employees gain ownership rights to their awarded equity and what criteria they must meet. Organizations may choose shorter vesting periods for new hires to attract talent while opting for longer vesting periods for existing employees to increase retention. 

Global organizations should be aware that they may face additional challenges when offering equity bonuses and other equity compensation to foreign employees. They must account for varied tax obligations across different jurisdictions and be ready to issue and manage global equity bonuses in accordance with local regulations and foreign tax laws.

2. Determine sizes of equity grants

The allocation of equity should then be established, which includes deciding the percentage of equity distributed among eligible employees and how it will be divided among them. For example, an organization may distribute its equity pool among eligible employees based on their market salary rate, seniority, performance, or role. Organizations should consider their equity pool like a financial budget and only assign equity as needed to preserve a portion for future hires or investors. 

Organizations can effectively manage salaries and bonuses through compensation management software to accurately assess current compensation structures and allocate equity bonuses accordingly.

3. Communicate offerings 

Once all criteria have been established, organizations can announce their equity bonus program to eligible employees and provide them with an overview of the potential benefits of equity ownership. Employees may need help understanding the value of equity, so organizations should employ various communication strategies to convey its importance. 

Written resources, presentations, and webinars can help organizations effectively explain the concept of equity ownership and its potential financial benefits. Organizations are also advised to incorporate discussions about equity into regular company updates, as this can prompt employees to consider how their company’s performance might impact the value of their equity bonuses.

4. Evaluate progress

Organizations should regularly review the progress and effectiveness of their equity bonus programs by assessing employee performance, analyzing retention rates, and soliciting feedback from employees. They will then have data and employee insights to make adjustments or enhancements to ensure the program is sustainable and delivers the desired results. 

Other forms of equity compensation 

Organizations may opt for alternative forms of equity compensation due to various factors, such as employee preferences, share dilution, and tax implications.

Employee Stock Options

Employee Stock Options (ESOs) are a form of equity compensation included in corporate benefits packages, allowing employees to purchase company stock at a predetermined price. This scheme aligns employees' interests with those of the company and its shareholders, serving as both a motivational tool and a retention strategy by giving employees a vested interest in the company's success.

ESOs come in two main forms: Incentive Stock Options (ISOs) and Non-Qualified Stock Options (NSOs). ISOs, offered primarily to key employees and top management, provide tax benefits under certain conditions, treating profits as long-term capital gains. NSOs, available to employees at all levels as well as board members and consultants, are taxed as ordinary income but are more flexible and easier to administer than ISOs.

Restricted Stock Units (RSUs)

Restricted stock units are a common alternative to stock options and provide more incentive for employees to stay with a company over a long period. They are issued through a vesting plan, which controls when units become actual shares that employees own. 

Performance Shares 

Also known as performance stock units (PSUs), performance shares grant equity to employees if specific business targets or benchmarks are met. 

Stock Appreciation Rights (SARs) & Phantom Stock

Stock Appreciation Rights and phantom stock reward employees with compensation, such as annual bonuses, tied to the company’s stock performance, without actually granting shares or options. This ties employee compensation to stock performance without some of the complexities of issuing equity.

Employee Stock Purchase Plans (ESPPs)

An employee stock purchase plan allows employees to purchase stock in their company, usually at a discount of 5% to 15%.

How to handle equity compensation in a global organization

Companies offering equity compensation to international employees face significant challenges, including understanding the diverse types of equity awards and ensuring compliance with varying tax and employment laws across countries. Each equity option, ranging from Restricted Stock Units (RSUs) that do not require an exercise price, to Non-Qualified Stock Options (NSOs) suited for contractors, carries distinct implications for both the business and its employees. 

Additionally, the process demands a thorough grasp of local regulations to mitigate risks like tax noncompliance and worker misclassification. Managing these complexities typically requires establishing comprehensive systems for global payroll processing, company valuation, and equity plan registration. Phantom shares are sometimes used to avoid these complications.

Given the intricate nature of administering a global equity plan, many organizations choose to collaborate with a specialized compensation management partner. This allows them to streamline the process and ensure compliance while leveraging equity compensation as a strategic advantage in global talent acquisition.

Summary 

Equity bonuses are a viable option for businesses that want to attract new employees or incentivize existing ones, particularly for smaller companies with limited budgets. To successfully provide equity bonuses to senior and executive employees, organizations must first outline the criteria and size of the bonuses. After communicating their offerings to employees, businesses can administer the equity bonuses, which may be subject to a vesting schedule, and assess their impact on retention rates, performance, and employee morale. 

With specialized compensation management tools and analytics software, businesses can streamline this process and ensure their equity bonus plans align with their long-term business objectives. Contact us to learn how we can help you enhance equity bonus management at your organization.