Many people think that equity compensation is automatically equal to a windfall – the next Facebook or Instagram story.
But the truth is, this is usually not the case for the majority of us. Equity can be a great form of compensation, since it aligns incentives between employees and employers and enables employees to build long-term wealth. However, while equity compensation may provide significant upsides, beware: it can create complications relative to cash compensation. That’s why it is so important to understand what kind of equity you are being offered and how much to see how it impacts your overall net worth and future financial plans.
Ask These Questions When Discussing Equity Compensation with Your Employer (or Potential Employer)
Who Is Offered Equity Compensation?
Equity compensation is applicable in both the startup and corporate worlds. But the scenarios are not all equal, and not all recipients find themselves on a path to riches, contrary to popular perception. The extent to which you will benefit from an equity compensation package depends not only upon the performance of the stock, but also on how well you manage key decisions relating to your equity. In particular, understanding the type of equity you have and the associated tax implications is critical to your success – as is understanding the risk of investing in an individual stock versus a diversified portfolio.
The first step to making sense of your equity compensation package and its impact on your overall financial picture is asking clarifying questions about the offer before you accept the package. It’s important to fully understand what you are being offered and how it will affect you before you sign on the dotted line.
When it comes to employee equity compensation, you’re oftentimes putting yourself into a speculative position.
Sure, you have the chance of potentially coming into a big windfall, but keep in mind that you’re also placing a bet that the employer who signs your paycheck is going to be successful.
That’s why it’s important to understand what awards you are being offered, what the vesting schedule is in your situation, and what tax consequences you might have so you aren’t unnecessarily overpaying, while also managing concentration risk within your overall allocation. Also, you should understand that while taxes are an important aspect to consider, they should not be the underlying reason a diversification strategy isn’t implemented.
To learn more, read our free “Guide to Employee Equity Compensation.”