Employee Equity Explained: Basics of Stock Options, Restricted Stock, and Restricted Stock Units
Issuing equity to employees in a startup, or any business, is a great way to compensate and incentivize employees. However, employers and employees are often confused about the various types of equity compensation available and the pros and cons of each type of employee equity. In this series of blog posts on employee equity, we will continue our discussion of employee equity compensation plans by detailing the various types of equity that employers can grant and lay out the reasons for choosing one over the other.
When someone receives “equity” in a company, this means that they are receiving stock or future rights to stock in the company. By owning stock in a company, that person will then become a shareholder, which entitles them to various rights. Often, startups and growth companies are C corporations and not LLCs, so the focus of this series will be on stock in C corporations. LLC equity compensation can be quite different and will not be covered in any detail in this blog posts series.
Stock in a corporation is either common stock or preferred stock. Sometimes you’ll hear the term “founders stock,” which is typically just common stock allocated at a company’s formation to the founders. But “founder’s stock” rights are usually the same as the rights of other common stock holders. It’s unusual for a startup to issue preferred stock to anyone but an investor in the company, so we’ll only be discussing common stock through this series.
The three types of employee equity that we’ll be discussing in this series are: stock options, restricted stock, and restricted stock units.
Employee Equity: Stock Options
Stock options are contracts that allow an employee to buy shares at a fixed price. These options are generally subject to specific conditions and almost always are subject to a vesting schedule. Stock warrants are another kind of option to purchase stock. They are generally used in investment transactions such as a convertible note offering and do not typically include service-based vesting provisions or termination at end of service.
Employee Equity: Restricted Stock
Restricted stock is simply stock (typically common stock) that is subject to forfeiture upon certain events and is subject to a vesting schedule.
Employee Equity: Restricted Stock Units (RSUs)
RSUs are agreements to issue shares of stock to the employee according to a vesting schedule. Each unit represents one share of stock that you will receive when the unit vests.
In the following posts in this series we will dive into more detail on stock options, restricted stock, and restricted stock units.
If you’d like to learn more about granting employee equity and planning the right stock structure for your company, please feel free to contact us today.