Exploring Chronus Level Equity Deep Dive Series: Geeking Out About Equity
Introduction
In the tech industry, one of the hottest topics of discussion is equity. Equity-based arrangements are a way of compensating employees and investors alike, bringing in advantages and disadvantages dependent upon the approach and context. Chronus Level Equity Deep Dive series is a series of informational articles on the concept of equity in the tech industry, examining its nuances and exploring the questions that surround such an important aspect of corporate finance. The purpose of this blog series is to equip tech professionals with a better understanding of the equity-based compensation structures and to encourage discussion on the topic.
What is Equity?
Equity, in a business context, is a way of providing incentive and ownership to key investors and tech professionals, providing a stake in the business without recourse to a cash payment. The concept of equity compensation usually results from the issuance of stock options or restricted stock units, in addition to wages or other bonuses, as a means of incentivizing employees and external investors. When the company experiences their expected growth, holders of equity are rewarded with increasing share prices and improved market value.
Understanding Equity Deep Dive Series
The Chronus Level Equity Deep Dive series is a multi-part series of articles that provide an in-depth understanding of equity and the various forms it takes in the tech industry. Understanding the nuances and legislations that govern the use of equity in tech is largely misunderstood and frequently ignored, and the series covers these topics including taxation, regulations, and the legal aspects of equity in a tech business context.
The articles provide an overview of the different structures built around equity and the various types of equity compensation that are available in the industry. As well as aiming to explain the complexities of equity in a manner that is approachable and practical, the series of articles also discuss when it may be appropriate or beneficial to use equity and how to structure equity arrangements for the maximum benefit for all parties involved.
The deeper level of equity understandings is also provided, covering topics such as options, restricted stock and phantom stock, as well as the processes behind calculating these forms of compensation. The interpretations of equity given in the series open the door to better considering the positives and negatives associated with its use and an opportunity to think through the potential implications and benefits of equity compensation.
In the articles, details of the different types of offerings, such as options and restricted stock, are explained. These offerings allow tech professionals and investors to purchase unvested shares over a period of time, with details of share pricing, timeframes and conditions are all explored. Additionally, amendments that can be made when the conditions of the agreement have to be changed due to unforeseen circumstances.
FAQ’s
When it comes to equity-based compensation, there are a lot of questions that arise. These can range from the most basic understanding of what equity is to learning more about opting in to certain arrangements. To provide an understanding of equity as a whole, here are some of the frequently asked questions that come up.
Q: What is equity?
A: Equity is a stake in a company that can be offered to employees or investors as a partial payment in return for their contribution. Equity arrangements are often based on stock options or restricted stock units and can offer financial or other reward when the company experiences their expected growth.
Q: What is a restricted stock unit?
A: A restricted stock unit (RSU) is a form of equity-based compensation in which the employee or investor is given the right to purchase unvested stock at a predetermined price over a given period of time. This approach is sometimes seen as being more beneficial to the investor or employee than a cash payment, offering a stake in the company instead.
Q: What is the difference between an incentive stock option and a non-qualified stock option?
A: An incentive stock option (ISO) is an arrangement that allows an investor to purchase a specific number of shares at a predetermined price from their employer. With an ISO, the investor is not liable for taxes when it comes to the purchase of the shares. A non-qualified stock option (NSO) provides the same benefit but does not offer the same tax advantages, so the investor must pay income tax on the value of the shares at the time of purchase.
Q: What is phantom stock?
A: Phantom stock is a form of incentive compensation in which a company grants shares of non-tradable stock to an employee or investor. This form of equity-based compensation allows the employee or investor to benefit from the increase in the company’s share price, even though they do not have an actual ownership stake in the company.
Example
To provide a better understanding of equity, it is important to explain an example of how it may be used in tech. One company, Uber, offers a complex series of equity-based compensation arrangements as an incentive for their engineers and other tech professionals.
Uber’s equity agreements allow their employees to purchase up to 5% of the company’s shares at a price of $0.71, with the option to purchase up to 20% of the company’s shares at $2.15.
In addition to the share offer, Uber also offers a Restricted Stock Unit (RSU) where they award shares to key engineers of their team. This RSU is based on performance over a 3 year period and at the end of the period, the employee receives a cash payment or the option to purchase the shares at a discounted rate of $0.71 per share (the same rate as the equity offer).
The Uber example provides a good understanding of the complexities of equity and how it all comes together to provide similar prospects for both employees and investors alike.
Conclusion
Equity-based compensation is an important part of many tech businesses and understanding the complexities surrounding such an arrangement is vital in order to make the most of it. Chronus’ Level Equity Deep Dive Series provides a detailed overview and appreciation of equity arrangements, from the most basic concepts to the most detailed regulations. The series also examines how equity may be used, understanding the merits and demerits and how to properly structure the agreement for the benefit of those involved.
FAQ’s
Q: What is meant by “equity-based compensation”?
A: Equity-based compensation refers to any arrangement whereby investors or employees are compensated in the form of shares or stock options in lieu of a cash payment.
Q: What are the advantages of equity-based compensation?
A: Equity-based compensation can provide investors and employees with a stake in the company, allowing them to benefit from the long-term success of the business. It is also a way to incentivise employees based on their performance, allowing them to share in the rewards of a successful business.
Q: What types of equity-based compensation are available?
A: Options, restricted stock and phantom stock are the most commonly used forms of equity-based compensation. Options allow investors and employees to purchase shares at a predetermined price, usually at below market price. Restricted stock awards offer the holder the right to purchase shares at a later date, at a predetermined rate. Phantom stock programs give the holder a non-tradable stock that can benefit from the increase of the company’s share price without having an actual ownership stake.
