Should you choose salary or equity?

In today’s competitive labor market, companies are looking for any possible advantage when making offers to prospective employees. Increasingly, one of the strategies is giving candidates the option to be paid in equity in addition to their salary.

Among public companies, 43% offer equity compensation to executives and all employees, while 35% of private companies do the same, according to a report from Morgan Stanley at Work. Equity compensation has the potential to become incredibly valuable, but its worth isn’t guaranteed and can fluctuate significantly over time.

In many cases, understanding an equity offer is more complicated than understanding your salary and other benefits. Whether you’re facing the option during the job hunt, or during your annual review—i.e. equity in place of a raise—here’s what you should ask yourself before making a decision.

What type of equity am I being offered?

Your company may pay you using different forms of equity compensation and it’s important to understand which one you’re receiving. Some of the most common types of equity compensation include the following:

• Stock options

Stock options give you the right to purchase company shares at a later time but at the preset price. In other words, if the price of the company’s stock goes up before you make the purchase, you get the shares at a discount.

• Restricted stock or restricted stock units (RSUs).

With this form of compensation, you receive shares of the company (restricted stock) or promises that the company will give you shares later (restricted stock units). Typically, restricted stock owners don’t have the same voting rights as other shareholders.

• Employee stock purchase plans.

This is the opportunity to purchase shares of stock (often at a discount) through payroll deductions, similar to 401(k) contributions.

When will you own the equity?

Often, employers award options or RSUs on a vesting schedule, meaning that employees don’t actually own the stock (or the right to exercise their options) until that equity has vested. (Equity vesting works similarly to vesting for an employer match in a 401(k). While the equity will post to your account, if you leave the company before hitting predetermined milestones, ownership of unvested equity reverts back to the company.) A typical schedule would see one-quarter of your award vest once a year over four years. So when you’re evaluating the offer, it’s essential to think about how much you expect company shares to be worth at that time, and to keep in mind that if you leave the company before your shares have vested, you will forfeit the remaining shares.

You’ll also need to think not only about what your equity compensation is worth now, but what it could be worth in the future.

“Expectations have been pretty aggressive in terms of company growth and growth targets,” says Tanya Jansen, co-founder of the compensation consultancy Beqom. She advises employees to budget for the long-term “worst-case scenario,” rather than thinking that, since the company is growing, the growth trajectory is bound to continue. “We see it every day in earnings reports,” Jansen says. “Companies will slow down, and their share price will recalibrate, and the value of your equity package will recalibrate as well.”

Do you have a plan for the associated taxes?

The rules vary depending on the type of equity compensation you receive.

“The challenging part is that certain forms of equity compensation have more favorable tax treatment than others, depending on when you exercise or sell,” says Rachelle Tubongbanua, a private wealth advisor at U.S. Bank Wealth Management. “It’s important to consult a tax professional to fully understand the tax consequences of your equity compensation.”

If you have incentive stock options (ISOs), you’ll owe taxes on the difference between the price you pay and their value when you exercise them, if you’re subject to the alternative minimum tax. With nonqualified stock options (NSOs), on the other hand, you’ll pay income tax on that difference when you exercise. If you receive RSUs, you’ll owe income taxes on the value when they vest.

If the shares increase in value and you later sell them, you’ll owe taxes again. The amount you pay will depend on how long you own them. If you sell in less than a year, you’ll owe ordinary income taxes, but if you hold them for longer than that and then sell, you’ll owe capital gains taxes.

How will you adjust the rest of your finances?

If you’re receiving a large portion of your compensation in equity, you may need to make some changes to deal with the concentration risk of having too much of your portfolio invested in a single stock or asset class. This is even more of a risk when you’re working at the company in which you’ve invested, since your income is also dependent on the performance of that company.

You can reduce the risk by diversifying the rest of your investments into other asset classes, and even considering selling some of your position in the company in case it amounts to more than 5% to 10% of your portfolio, Tubonbanua says.

Another factor to consider, particularly if you’re receiving equity in a private company, is that you may not be able to sell or convert that equity into cash as quickly or easily as you could other assets. That means you may need to boost your allocation to other liquid assets to meet cash needs in the short term.

Are you comfortable with the risk of being paid in equity?

One of the most important factors to consider when receiving equity compensation is that the value of shares in a company change over time. That means that the value of your equity compensation could go up substantially, or it could decrease. If the company goes out of business entirely, your equity compensation could be completely worthless.

That risk of total loss may be lower for public companies, than for startups. Of course, the potential increase in equity value for startups—if they make it—is much larger as well. Within the startup space as well, there’s typically a higher risk for very young companies still in seed funding stages, versus those that are well funded and close to an initial public offering or sale. You’ll need to consider your personal appetite for risk, and how the equity can help—or hinder—your progress toward other money goals.

“Everyone has different things going on in life and different financial considerations,” says Aaron Shapiro, founder and CEO of Carver Edison, which helps companies increase stock plan participation rates. “There’s a risk continuum, where companies earlier in their life are eager to give out bigger equity grants and lower salary amounts. There’s more risk attached to that, but there can be more reward if the candidate is lucky enough to be on a rocket ship.”

But there’s also a risk at public companies, during times of economic volatility, like the markets have experienced in the past few years. More than 80% of plan participants in 2022 told UBS they were highly concerned about the value of their equity awards.

How do you feel about the rest of the offer?

Your salary and equity are just one part of your overall compensation package. You’ll also need to consider the value of other benefits, such as health insurance and the 401(k) plan, as well as intangible benefits like flexibility around when and where you work and how the job will help with your future career.

“Any thinking about your salary and equity offer has to be done through the lens of this broader employer-value proposition that’s being offered,” says Jesse Meschuk, a global career and HR expert and senior advisor with Exequity. “The candidate should keep all of that in mind when they’re thinking about where they may want to negotiate or push on the offer.”

Photo: Welcome to the Jungle

Follow Welcome to the Jungle on Facebook, LinkedIn, and Instagram to get our latest articles every day, and don’t forget to subscribe to our newsletter!