What is Stock Compensation?

Several years ago, if someone told you that they left their high-paying job to start a business of their own, you would have been surprised. Fast forward to now, the high-paying jobs have shifted to new-age startups that are being created every day. There are more than 50,000 startups in India, and 53 of them have become unicorns. A unicorn startup is when it is valued at $1 billion. The surge in the number of startups has made India the third largest startup ecosystem in the world. However, how are these startups driving their growth?

The answer lies in their hiring process. Startups with billions of dollars in capital amount tend to hire employees that are skilled and experienced. As skilled and experienced employees are already working in good companies that pay them well, these startups promise them a hefty salary along with numerous other benefits. These benefits are vital for a startup to woo skilled employees for joining their relatively new startup.

There are numerous benefits that a startup can provide its employees. However, as they don’t want to spend their capital on business growth and not internal matters initially, they prefer to offer these employee benefits in the form of stocks.

Understand the Stock Compensation

Companies or startups, before they go public, raise funds by offering their unlisted shares to investors. For example, if a startup wants to raise Rs 100 crores, it has to offer certain shares in its company to the people who are investing in their money. After the deal, the investors become the owner of the startup based on the proportion of the shares they hold. When the startup goes public, the investors sell their shares and earn hefty returns on their investments.

Similarly, startups offer their existing Employee Stock Option.(the unlisted shares) at a base price, which is very low when the startup just launched. These stock options are known as stock compensation and are considered a reward for the employees for their hard work. This is an alternative to providing them with a cash bonus. The shares under stock compensation come with a vesting period. A vesting period is the minimum amount of time employees must hold the shares until they can exercise their right to sell the shares.

Types of Stock Compensation

There are four types of stock compensation:

• Non-qualified stock options (NSOs): In this type of stock compensation, employees are required to pay taxes in cash based on the difference between the grant price and the exercised price.
• Incentive Stock Options (ISOs): These types of stock compensation are provided to employees with special tax advantages. They are available to both employees and non-employees such as directors, consultants, etc.
• Restricted Stocks: Restricted stock units allow employees to receive shares as a gift or by purchasing after working for a predetermined number of years. Employees can only exercise these types of stock compensation after the vesting period.
• Performance Shares: This type of stock compensation in which company stocks are offered to the employees after they have achieved certain predetermined goals.

Example of stock compensation

Suppose you are working in a company and it offers you 1,000 shares at a base price of Rs 50. The stock compensation options vest 25% every year for 5 years. As the base price is Rs 50, you will pay Rs 50 per share, regardless of the unlisted or listed shares rising in their value to any amount.

Final Words

Stock compensation is a great way to add value to the company, and its employees and contributes to the motivation level of employees to work hard. It also ensures that the company limits its employee turnover ratio as employees tend to stay until the vesting period.