Should you take equity in exchange for salary? Equity payments are common with many start-up companies and some mature companies. They allow younger companies who may be lacking in cash to save on salary by offering their employees alternative means of compensation. Larger corporations may also use this strategy to attract and retain talent. Think of equity compensation as a non-cash payment that accompanies a salary. But should you accept it?
What is Equity Compensation?
Equity compensation is a non-cash payment made to employees that is usually in the form of stock. Typically, it includes options, restricted stock, or performance shares.
The main risk is that equity compensation may not pay off. If the company goes out of business, or if the stock drops, then you may not make any money. The opposite is also true, however. Many people have made small fortunes taking equity as a form of compensation.
There is typically a vesting schedule tied to this form of compensation, so you will be tethered to your job until a certain period has lapsed. This strategy is used by employers to retain talent for X amount of time.
Tax consequences of equity payments can be complicated and vary by the type of structure that exists. If you are receiving this type of compensation you will want to speak with a tax professional before exercising your options.
Should You Accept Equity as a Form of Compensation?
Unfortunately, there is no one size fits all answer to this question. There is also no magic formula or ratio that you can use as a guide. It comes down more to risk versus reward and to your personal beliefs about how successful your employer will be looking forward.
You may be offered an option to purchase 1000 shares of a stock at $25. In one year, you are vested in 200 shares, and the stock price is $50 a share. If you exercise your options, you will make an instant $5000. Of course, if the stock price drops to $10 a share your options would be worthless until the share price rises above $25. You can see why there is risk with accepting equity payments.
A good strategy is to negotiate a salary that you are comfortable with. In other words, don’t accept a below-market salary in hopes that your options will make up the difference. Structure a deal so that you can comfortably live on the salary alone. Any equity payments that you might receive will be a nice bonus but not a necessity.
The other option is to simply negotiate a market rate salary and then try to further negotiate options as an add-on.
So, should you take equity in exchange of salary? Equity compensation is used by employers to preserve cash and to attract and retain talent. Employees can benefit handsomely if the stock price of their employer rises. But they can also lose everything should the price drop, or worse yet, the company goes out of business.
Weigh your options, do your homework, and don’t settle for a salary that puts you too far below fair market value. Think of your equity payments as a nice bonus should they come to fruition but not something that will financially devastate you if they don’t work out.
Writer and Investor. Based in the Pittsburgh, PA area, Brian holds full-time employment as a Warehouse Manager for an electronics firm. Brian enjoys wealth building, investing, gardening and the great outdoors. Brian holds a B.A. in Environmental Studies from the University of Pittsburgh and an MBA from Robert Morris University.