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Competitive compensation goes beyond just a paycheck. Because many key hires are swayed not by a salary alone but also by other forms of compensation, equity compensation is an excellent option for companies (especially small and midsize businesses, as well as startups) looking to attract and retain top talent. 

Stock Options

The most basic forms of equity compensation are stock options: as part of their compensation, employees receive some company stock and become partial owners of the company. Stock options can grow in value when the stock's price appreciates or if the stock yields regular dividends.  

There are two types of stock options: 

• Common stock. This is the type that most people are familiar with. Someone purchases a company's stock and gains voting rights as a partial owner of the company. 
• Preferred stock. This type is more income oriented. When someone owns preferred stock of a company, they don't gain voting rights, but they do receive paid dividends before common stock shareholders do.                                       

Offering stock options to employees is usually preferred by early-stage, high-growth startups. It is a common practice among technology companies with projected meteoric growth. 

Restricted Stock Units

Like stock options, restricted stock units are a form of equity compensation in which the employee is given company shares. Unlike stock options, however, restricted stock units follow a vesting plan with a distribution schedule that depends on fulfilling a specific condition. Possible conditions include completing a particular achievement at work, hitting a milestone in the company, or waiting out a fixed vesting period.  

Unlike stock options, restricted stock units have no value until the vesting is complete. Fair market value is assigned when vesting begins, after which a portion of the shares is withheld to pay for taxes, and the rest are given to the employee. 

Companies commonly utilize this type of equity compensation to encourage employees to stay with the company for the long term and to drive performance to increase share value. 

Employee Stock Purchase Plans

Another way to offer equity compensation to employees who want it is to offer an employee stock purchase plan (ESPP), which lets employees purchase company stock at a discount (compared to fair market value). This type of program encourages employees to become more invested in a company's performance and growth and also offers the company some liquidity. 

Stock Appreciation Rights

Another way to compensate employees with equity is to give them all the benefits of owning a stock without having to purchase it themselves. Employees who receive stock appreciation rights are paid the excess amount of the fair market value on the exercise date over the grant date. Unlike regular stock options, stock appreciation rights don't require a cash outlay. They incentivize employees to retain them.  

Phantom Stock Units

Another form of equity compensation—and one that is usually used with executive hires—is phantom stocks or mock stocks. As the name suggests, phantom stock units offer the same benefits as owning company stock without actually owning company stock. (Consequently, they enable employees to enjoy large cash payments without diluting the company's equity.) Phantom stock plans come in two forms: appreciation-only phantom stocks refer to a payout equivalent to only the excess value of the fair market value of the company stock on the exercise date compared to that of the grant date; and full-value phantom stocks refer to a payout equivalent to the value of the underlying stock and the value of appreciation. 

Deferred Compensation

Equity compensation doesn't always take the form of company shares or stock. Deferred compensation, which is commonly offered to executive hires, is the practice of setting aside a portion of an employee's compensation to be paid out at a later date for tax benefits. Some examples of deferred compensation plans include retirement plans, pension plans, and deferred savings and stock-option plans. (Companies usually offer deferred compensation plans to key employees whose tax situations could benefit from the deferment.) 

Check with the Experts

Although granting equity compensation has many benefits, it also comes with its fair share of complications. In general, companies should seek guidance from equity compensation professionals before implementing any type of program. Good advice can help an organization identify and implement the tools that will best help it attract and retain top employees without having negative consequences down the road.