Equity Compensation - Comparison of Plan Types: Including Stock Options, RSUs and Stock Purchase Plans

Equity Compensation for

Compensation Professionals

Ending the State of Confusion

Marianne Snook, CEP: CEO, Stock & Option Solutions

Dan Walter, CEP: President and CEO, Performensation

With experience in human resources, payroll, and equity

administration, Marianne offers a unique background that has

given her the tools to identify and implement creative solutions

for SOS clients. In her over 25 years in equity plan

management, she has held positions as a director of a major

outsourcing provider, an independent consultant, and an

internal stock administrator. These experiences allow her to

view all the advantages and disadvantages of various stock

administration solutions. Marianne speaks on both a local and

national level on various facets of stock program

administration. A Certified Equity Professional, she is also an

active member of the National Association of Stock Plan

Professionals and the National Center of Employee

Ownership.

Dan Walter, CEP, is the President and CEO of

Performensation. Dan has assisted companies with both

executive and broad-based compensation programs since

1994. Dan’s expertise includes equity compensation,

performance-based pay, and talent management issues.

His experience with these programs includes philosophy,

diagnosis, design, communication, administration, and

reporting. Dan is considered an industry thought-leader for

all forms of equity, including stock options, restricted shares

and units, stock purchase plans, and performance-based

programs. In addition to his focus on plan design, he has

architected software solutions, administrative and

technological best practices for these programs.

Dan Walter

President and CEOPerformensation

Marianne Snook

CEOStock & Option Solutions

Tel: +1 415 625-3406

[email protected]

www.performensation.com

Tel: +1 408 979-8700

[email protected]

www.sos-team.com

Total Rewards Model

LET’S PUT THEM IN FAMILIES BY SIMILAR QUALITIES

Courtesy of World at Work

Performensation / SOS

Total Equity Compensation Model

THESE ARE THE

ACRONYMS YOU

HEAR IN

MEETINGS AND

READ IN ARTICLES

ISO

NQSO

RSSRSUESPP

SAR

PSA

DSA

DPP PUACS

OSSAR

MS

U PA

MUA SA

NQESPP

IF YOU’RE LUCKY

YOU MAY ACTUALLY

GET WORDS AND

NAMES FOR EQUITY

COMPENSATION

INSTRUMENTS

INCENTIVE STOCK OPTIONS

NONQUALIFIED STOCK OPTIONSRESTRICTED STOCK SHARES

RESTRICTED STOCK UNITS

IRC 423 ESPPSTOCK APPRECIATION RIGHTS

PHANTOM STOCK

DEFERRED

STOCK

DIRECT PURCHASE PLANS

PERFORMANCE UNITS

CA

PP

ED

ST

OC

K

OP

TIO

NS

STOCK SETTLED SARS

MA

RK

ET

ST

OC

K

UN

ITS

PERFORMANCE

AWARDS

MEMBERSHIP UNIT AWARDS

STOCK AWARDS

NONQUALIFIED ESPP

EVEN THOSE

MAY NOT BE

VERY HELPFULLET’S PUT THEM IN

FAMILIES BY SIMILAR

QUALITIES

APPRECIATION ONLYSTOCK OPTIONS

STOCK APPRECIATION RIGHTS FULL VALUERESTRICTED STOCK

SHARES

RESTRICTED STOCK UNITS

PHANTOM STOCK

PERFORMANCE UNITS

DEFERRED STOCK

STOCK PURCHASEIRC 423 ESPP

NQ ESPP

DIRECT PURCHASE

Three Main Equity Families

Full Value Appreciation Purchase

Restricted Stock

Restricted Stock Units

Phantom Stock

Deferred Stock

Incentive Stock Options

Non-Qualified Stock Options

Stock Appreciation Rights

IRC 423 Qualified ESPP

Non-Qualified ESPP

Direct Purchase

Three Main Equity Families

STRUCTURE

No purchase cost to

participants

Generally taxed when

restrictions end

If time-based vesting:

Compensation Expense =

Intrinsic Value at Award Date

Built-in gain works well with

performance-based vesting

STRUCTURE STRUCTURE

Purchase cost set at grant

date. Usually equal to stock

price

Generally taxed when

purchase / exercise is

elected, unless tax qualified

If time-based vesting:

Compensation Expense =

Black Scholes value

Tax qualified status available

under IRC 422

Purchase price based on

either grant date or

purchase date

Discount commonly applied

to purchase price

Generally taxed at time of

purchase, unless tax

qualified

Compensation Expense =

Black Scholes Value of

estimated shares to be

purchased

COMPENSATION

PRIORITY

Provide tangible

compensation beginning

the date of award

Less dilution than

appreciation grants, but

same compensation cost

Retention focus, but only

for 3-5 years

No ordinary income

avoidance, limited

deferral opportunities

Provide potential

compensation beginning

at grant date

Requires higher dilution

to deliver same modeled

value as full value

awards

Risk of no immediate

value upon vest, or ever

Potential to allow move

of ordinary income to

capital gains

Provide simplified

method to augment pay

by purchasing shares

Dilution can be controlled

via limits, but more

difficult with large

companies

Low risk, generally

conservative reward

Potential to allow move

of additional ordinary

income to capital gain

COMPENSATION

PRIORITY

COMPENSATION

PRIORITY

FIRST SOME TERMS

AND DEFINITIONS

TO KEEP ALL OF US

ON THE SAME PAGE

OptionProvides the participant the option to

exercise (purchase) stock at a later,

generally at a price set on the grant date

Restricted

The holder possesses stock or units

(synthetic stock) that is not entirely

controlled by them until the restrictions

lapse (vest)

DisqualifiedAny type of equity that had a tax benefit under IRC

421-424, where the participant chose to transact

the underlying shares BEFORE the prescribed tax

benefit period had been met

Tax benefit period is 2 years from the date of

grant and 1 year from the date of exercise or

purchase

QualifiedAny type of equity that had a tax benefit under

IRC 421-424, where the participant chose to

transact the underlying shares only AFTER the

prescribed tax benefit period had been met

Tax benefit period is 2 years from the date of

grant and 1 year from the date of exercise or

purchase

Non-QualifiedAny type of equity upon grant, does not meet the

tax benefit rules defined in IRC 421-424

Also, any ISO or ESPP shares that, prior to exercise, do not meet ALL of

the rules under IRC 421-424.

Examples

• Over the $100,000 Limit

• Outstanding beyond 3 months of regular termination

• Modified to so that grant price may not be at least 100% of Grant date

FMV

Based on longer periods than most

compensation and with no guarantees of

final values, every equity award can feel like

an extended journey across a sea.

But, all equity is not equal

You must always remember that the waters

may not be safe, and some tools provide

better protection than others

Take a guess at the equity instrument that

creates this path

discount = safety

limits = small gains

Which type of equity can provide this path?

$0 cost = ultimate safety

no limits = big gains

And that leaves

perhaps the best and

worst tool

no discount = limited safety

no limits + leveraged grant size = big gains (or $0)

SHOW ME THE

MONEY, OR AT

LEAST SIMPLIFY

HOW IT IS MADE

BUT WHEN ARE

SHARES ISSUED?

AREN’T THESE

DESIGNED TO

CREATE OWNERS?

Nonqualified

vs.

Incentive Stock Options

vs.

Stock Appreciation Rights

Incentive Stock Options (ISOs)

Attract and Motivate.

Retention when stock price is

growing steadily.

Pre-IPO and Publicly traded

companies (high-tech/biotech

and high growth sectors)

Execs at all sizes, High-tech

staff at Small to Mid-size

companies

Preferential tax treatment.

Limits on use. Highly

Leveraged. Pays only if price

increases

Complex valuation and

amortization. Difficult market

comparisons

Limits on Grant Price, Value of

Grant, Term of Grant and Term of

Plan. Shareholder approval

required within 12 months of BOD

adoption.

No tax withholding at exercise.

No Ordinary income if held for

qualifying period. Not applicable

to int'l participants. Alternative

Minimum Tax concerns

Difficult to show value if

underwater. Leverage can be

issue in highly volatile stocks. Tax

issues, Dispositions, AMT

Activity peaks and valleys. Grant

processing. Exercise processing.

Termination rules. Int'l issues.

Disposition tracking.

Primary Use Typical Plan Sponsor Typical Recipient

Main Features

Tax Issues

Accounting Issues

Communication Issues

Legal Issues

Administration Issues

Non-Qual Stock Options (NQSOs)

Attract and Motivate.

Retention when stock price is

growing steadily.

Pre-IPO and Publicly traded

companies (all sectors)

Widely used, grant size

generally based on position.

Consultants and Outside

BOD members

Highly Leveraged. Guaranteed

corporate tax deduction when

exercised. Pays only if stock

price increases

Complex valuation and

amortization. Difficult market

comparisons. Variable Fair Value

accounting for non-employee

service providers.

General plan documentation.

Detailed documentation when

used for outside BOD members.

Post-termination rules and

regulations.

Ordinary Income and Tax

withholding at Exercise. 409A

Supplemental Wages eligible

($1MM threshold).

Difficult to show value if

underwater. Leverage can be

issue in highly volatile stocks. Tax

issues at exercise.

Activity peaks and valleys. Grant

processing. Exercise processing.

Termination rules. Int'l issues. Tax

at Exercise.

Primary Use Typical Plan Sponsor Typical Recipient

Main Features

Tax Issues

Accounting Issues

Communication Issues

Legal Issues

Administration Issues

Stock Appreciation Rights (SARs)

Attract and Motivate Privately held companies.

Including S-Corps

Upper and Middle

Management

Can be settled in cash or stock.

Provides option-like features

without needing to deliver stock

Stock-settled treated like options

(fixed, Fair Value accounting).

Cash-settled require variable

accounting (quarterly adjustment

of Fair Value)

Possible ERISA issues with long-

term holding period on broad-

based plans. Generally not

deemed "stock" for S Corps

Taxed at time of exercise.

Ordinary Income and Taxes must

be withheld.

Comparison to options (stock

value no/no stock). Delivery of

only the appreciation rather than

whole grant

Limited support from brokers at

exercise (unlike options). Limited

overall software capabilities

Primary Use Typical Plan Sponsor Typical Recipient

Main Features

Tax Issues

Accounting Issues

Communication Issues

Legal Issues

Administration Issues

Restricted Stock Shares

vs.

Restricted Stock Units

vs.

Performance Stock Units

Restricted Stock Shares (RSS/RSA)

Attract and Retain. Motivation

added when awarded at

higher than $0 cost to

participant

Closely Held and Publicly

traded companies (less

volatile sectors)

Upper and Middle

Management

Value if price drops. Minimally

leveraged. Can be used to

satisfy Executive Ownership

requirements

Simple Valuation. Value is Intrinsic

value on award date. Cost essentially

equivalent to paying cash. Retirement

eligibility can result in accounting for

expense prior to vesting completion.

Private companies are subject to

Blue Sky laws. Public companies

are subject to SEC regulations at

the time of award.

No income or tax until vested. 83(b)

election to be taxed at award date. Sell-to-

Cover requires sufficient trade volume.

Withhold-to-cover requires sufficient

corporate cash. Retirement eligibility can

result in income and tax prior to retirement.

Event-based, forced income and

taxation. Comparison to Options

Award processing. Event planning

with other corporate issues.

Repurchases. 83(b) elections.

Dividend tracking. Share issuance

at time of award.

Primary Use Typical Plan Sponsor Typical Recipient

Main Features

Tax Issues

Accounting Issues

Communication Issues

Legal Issues

Administration Issues

Restricted Stock Units (RSU)

Attract and Retain. Motivation

added when awarded at

higher than $0 cost to

participant

Closely Held and Publicly

traded companies (mature

tech, less volatile sectors)

Widely used above

operational staff, often broad-

based as well

Value if price drops. Minimally

leveraged. Better internationally

than RSS

Simple Valuation. Value is Intrinsic

value on award date. Cost essentially

equivalent to paying cash.

409A considerations. Registration

of shares prior to award.

No income or tax until vested. Dividend

Equivalents taxable unless fully restricted.

Sell-to-Cover requires sufficient trade

volume. Withhold-to-cover requires

sufficient corporate cash. Deferral allowed

with sufficient notification.

Event-based, forced income and

taxation. Comparison to Options

Award processing. Event

Planning with other corporate

issues. Forfeitures. Dividend

Equivalent tracking. Share

movement at time of vest.

Primary Use Typical Plan Sponsor Typical Recipient

Main Features

Tax Issues

Accounting Issues

Communication Issues

Legal Issues

Administration Issues

Performance Stock Units (PSU)

Attract and Motivate

Established public companies

with history to support long-term

goal definition. Progressive

private companies

Upper and Middle

Management

Can set thresholds to ensure

payout even if performance is

below expectations Excellent

communication tool for high

performance

Simple Valuation. Complex accrual.

Expense booked is relative to probable

payout. No expense reversal if goals

are market based

409A considerations. Registration

of shares prior to award. 162(m)

considerations

No income or tax until vested. Dividend

Equivalents taxable unless fully restricted.

Sell-to-Cover requires sufficient trade

volume. Withhold-to-cover requires

sufficient corporate cash. Deferral allowed

with sufficient notification.

Regular communication required

to drive performance. Must

provide proximity to goal and what

still needs to be done to attain

goals

Stock admin systems do not

support. Dividends are difficult to

track. Difficult to correctly track

proximity and remaining effort to

reach goals

Primary Use Typical Plan Sponsor Typical Recipient

Main Features

Tax Issues

Accounting Issues

Communication Issues

Legal Issues

Administration Issues

THE BASICS

OF OPTIONS

AND SARS

PR

ICE

S

TIME

THE KEY IS

EXERCISING AT THE

RIGHT TIME (AND

THAT’S HARDER

THAN IT SOUNDS)

THE VALUE

OF NOT

PAYING FOR

THINGS

IT SEEMS PERFECT UNTIL YOU LOOK CLOSELY.

MOST PEOPLE ARE CERTAIN THEY WOULD HAVE

TAKEN ADVANTAGE OF THE HIGHEST PRICES!

WHAT ABOUT

RSU VS NQSO?

AN EXAMPLE OF THE

COMPENSATORY DIFFERENCES

AND…THEY BOTH WIN, SOMETIMES

SO…

HOW DO

ESPPs WORK?(and try to be quick about it,

you’re running out of time!)

SOME MORE

ABOUT

INCENTIVE

STOCK OPTIONS

(ISOs)

TAXES

RESTRICTED

STOCK UNITS

(RSUs)

BRIEFLY

IF YOU COUNT PERFORMANCE UNITS

(and we usually do) THESE MAKE UP MORE

THAN 50% OF THE TOTAL REWARDS

DELIVERED TO MANY EXECUTIVES

BUT WE ONLY

GRANT NON-

QUALIFIED

STOCK OPTIONS

FINANCE PEOPLE LOVE THIS!

EMPLOYEE STOCK

PURCHASE PLANS

(ESPPs). SO MANY

FEATURES, SO

LITTLE TIME

WE’RE ON A

ROLE SO LET’S

CLOSE THIS

OUT STRONG

nonqualified vs. incentive stock options

Corporate tax deduction built-in

Very long-term

Simple administration

No limits

Income to participant can be mostly

Capital Gains

Great participant tax benefits

Very long-term

Desired in Tech firms and start-ups

Complex rules and administration

Limits for time, shares, values, people

Very few use tax benefits provided

No downside protection

Only performance link is stock

price

Exercise cost can be an issue

restricted stock awards vs. RSU

Instant ownership

No IRC 409A issues

Most lawyers understand these

Downside protection

Easy to link to performance conditions

No need to issue stock until vest

Potential for income deferral

Admin is fairly simple

Downside protection

409A issues: valuation, design, payment

terms

Dividend equivalent issues

Inflexible participant income and

taxation timing

Perhaps too much downside protection

Instant owners may not fit culture

Repurchase and termination

issues

Inflexible participant income and

taxation timing

Perhaps too much downside

protection

IRC 423 vs. NQ-ESPP

Excellent participant tax benefits

Discount does not have to =

immediate income and taxes

Partially funded by participants

Wildly flexible in design

Very easy and inexpensive to administer

Very easy to roll-out

Creates path to ownership

Mostly, or totally, funded by participants

Any discount is taxed at time of

purchase

Discounts generally too small to inspire

broad participation

Not competitive in tech firms and post-

IPO companies

Compensation expense and

accounting

Communication must be strong

Requires a system or outside

administration assistance

Does not work in every

jurisdiction

YOU HAVE

QUESTIONS,

WE HAVE

ANSWERS

LinkedIn: www.linkedin.com/in/danwalter

Twitter: @performensation

Performensation Blog:

www.performensation.com

Dan Walter

President and CEOPerformensation

Marianne Snook

CEOStock & Option Solutions

Tel: +1 415 625-3406

[email protected]

www.performensation.com

Tel: +1 408 979-8700

[email protected]

www.sos-team.com

LinkedInwww.linkedin.com/pub/marianne-snook/4/752/427

Twitter: @SOSXtra

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