Intro to Stock Comp

If you're brand new to stock-comp, start here!

Pre-Read: Key Questions This Article Answers

• What is stock-based compensation, and why do companies grant it to employees?

• What are the most common types of stock-based compensation?

• What are the key parts of stock-based compensation, and why are they important?

• How does stock-based compensation create value for an employee?

What Is Stock-Based Compensation ("Stock Comp")

Stock Comp is a form of compensation frequently granted to tech employees (and sometimes advisors, consultants, and others), providing an economic interest tied to the company's stock/equity. Unlike cash compensation, where the value is typically pre-specified and well-known, stock comp has a number of different (and more variable) attributes:

• The value is variable and tied to the company's stock/equity. If the company grows and the price of its stock increases, very likely so will the value of your stock comp. If the company struggles, the value of your stock comp will likely decline, and may even end up being worthless.

• It may be illiquid. If the company is not publicly traded (e.g. "private"), it could be years if/until you have the opportunity to realize any cash value in a sale. If the company is publicly traded, you likely have a few chances per year to sell.

• Structured to vest over time (per the vesting schedule). Stock comp is typically granted pursuant to a vesting schedule. That schedule specifies how many shares of stock you earn (e.g. RSUs, RSAs), or have the right to buy (e.g. ISOs, NSOs, SARs), over time. To learn more about vesting schedules see: Vesting Schedules

Why Do Companies Grant Stock Comp (vs. Cash)?

In Short, to Incentivize Employees

The value of stock-comp is a function of the company's equity/stock value, and as such, individuals with stock-comp have a direct financial incentive to increase the value of the company.

No incentive structure or tool is perfect, but allowing employees to directly financially benefit from the company's success aligns incentives between employees and the company -- which can encourage employees to work harder, make better decisions, increase retention, etc.

For Earlier-Stage Companies

Stock-comp may be a larger portion of your overall compensation. Working for a young company has risks, and the salary you receive may be below market (as the company is likely unprofitable + doesn't have large cash reserves). To compensate for the (potentially) lower salary and increased risk employees take, earlier-stage companies typically grant employees a higher level of stock comp.

At an early-stage company, you're "betting" on the company to a certain extent:

• Significant risk of stock comp being worthless. The odds of your stock comp being worthless are much higher at an early-stage company, as most ultimately fail

• Big upside potential if successful. But if the company is materially successful, the value of your stock-comp could be 5x, 50x, or more, its original value.

For Late-Stage and Publicly-Traded Companies

Stock comp is usually a smaller portion of your overall compensation. These companies typically have better cash flows and can afford to pay market (or above market) salaries. They still can/do grant stock compensation to employees (the desire to align incentives still exists), but the grant size is typically less given market salaries, less job risk, and if publicly traded, the ability to sell vested shares somewhat frequently.

At a later-stage or publicly traded company, stock comp is typically more predictable

• Less (relative) downside risk. It's much less likely the value of the stock comp is worthless (vs. early-stage)

• Less (relative) upside potential. It's also much less likely the value of the stock comp will increase in value multiple times over versus the original grant value.

What Are the Most Common Types of Stock Comp?

The type(s) of stock comp you will likely be granted and/or have the choice to participate in depends primarily on your company's life-stage.

• In earlier-stage companies, stock options (ISOs and NSOs) are primarily utilized

• In later-stage companies, most transition from options to only granting RSUs

• If a company is publicly traded, they may offer the ability to participate in an ESPP

• Less common types of stock comp include, RSAs, SARs, and Phantom Stock

ISOs

Incentive Stock Options. ISOs are one of the 3 most common types of equity compensation granted to employees. ISOs grant an employee the right (but not the obligation) to purchase a specified number of shares of company stock at a fixed price for a period of time. ISOs are similar to NSOs, but have a few unique tax-beneficial attributes. Because of that, they're more complex, and typically also require one to have a decent understanding of AMT taxation Learn More: 🔗 ISO Stock Options

NSOs

Non-Qualified Stock Options. NSOs are one of the 3 most common types of equity compensation granted to employees (and other individuals). They grant an individual the right (but not the obligation) to purchase a specified number of shares of company stock at a fixed price for a period of time. NSOs are similar to ISOs, but have less beneficial tax features. But because of that, they are also relatively easier to understand Learn More: 🔗 NSO Stock Stock Options

RSUs

Restricted Stock Units. RSUs are one of the 3 most common types of equity compensation granted to employees (and other individuals). RSUs grant an individual a specified number of shares of company stock over a period of time. The shares are tied to a vesting schedule, wherein the employee functionally earns a portion of the shares periodically (usually monthly or quarterly). RSUs differ in many ways from ISOs and NSOs, and are the least complicated type of stock based compensation.

Learn More: 🔗 Restricted Stock Units (RSU)

ESPPs

Employee Stock Purchase Plan. An employee stock purchase plan (ESPP) is a program commonly offered by public companies that allow eligible employees to purchase company stock, often at a discount. ESPPs can be a great way for employees to gain equity in their company and benefit as shareholders. In some cases, participating in a company's ESPP plan offers very limited downside risk with material upside potential.

Learn More: 🔗 Employee Stock Purchase Plans (ESPP)

Want a Side-By-Side Comparison of ISO, NSOs, and RSUs?

🔗 Comparison: ISOs/NSOs/RSUs

What Are the Key Components of Stock Comp?

• Stock-comp grant types can be in many forms. The most common three types are ISOs, NSOs, and RSUs. Less common are RSAs, SARs, and Phantom Stock.

• The number of shares stated in the option grant determines how many shares employees may purchase. Additional options must be earned through new grants to buy more shares.

• The vesting start date is (exactly as it sounds) the date the vesting begins.

• The vesting schedule determines when an employee receives ownership of a portion of the shares. It has many important sub-parts, including The start date, total length, vesting frequency, Cliff (if any) -- as well as potentially less common items like staggered schedules and acceleration.

• The exercise price applies to stock options (ISOs; NSOs; SARs), they have an exercise price. That price is fixed and is the price that you have the option (but not obligation) to buy shares at.

• The expiration date is the date on which a stock option grant expires (and shares can no longer be purchased).

Separately, while not necessarily a key component of the grant per se, the company VC valuation, 409A valuation, and how taxation works for a particular stock-comp grant are key items to understand

How Does Stock Comp Create Value for an Individual

Stock-comp (typically) creates value when the company's shares increase in value. Each type of stock-based compensation is linked to the value of the company's equity. As such, if the value per share of the company increases in value, the value of the stock-comp should increase a (roughly) commensurate amount as well. Said more simply: if the company does well, the value of your stock-comp will likely increase (which is the point and intent of granting it to you).

That Said, There Is Also Significant Downside Risk:

• For publicly traded companies, if the value of the company's stock declines, RSU grants will be worth less when they vest vs. when they were granted. And if you own stock options (ISOs or NSOs), a decline in the company stock price could make the options "underwater" (and therefore worthless).

• For private/pre-IPO companies, the risk is generally higher (although the prospective upside is usually larger as well). This is because the material majority of Pre-IPO companies fail to ever have a successful exit/liquidity event--and thus individuals are never able to realize any value from their stock-comp grants.

Related Pages

🔗 ISO Stock Options

🔗 NSO Stock Options

🔗 Restricted Stock Units (RSU)

🔗 Employee Stock Purchase Plan ("ESPPs")

🔗 [FAQ]: Why Do Companies Issue Different Types Of Stock Comp?