Choosing the Right Type of Equity Compensation for Start-up Company Employees

Grants of equity compensation provide an excellent opportunity for employees to earn additional income beyond salary and to acquire an ownership interest in the company. Equity compensation can be particularly useful to a start-up company, which may not have the cash necessary to adequately attract, retain and motivate employees with market-rate salaries. In certain industries, it is standard practice for a start-up company to include equity as a part of every employee's compensation package.

To make the best use of an equity compensation program, a start-up company must understand the legal implications, tax consequences and accounting treatment of granting each type of equity award. A start-up company could face personnel issues and public relations problems if, as a result of not understanding the tax consequences of granting a certain type of award, it causes its employees tax prob­lems that may have been avoided by using a different type of equity award.

This article provides an overview of the types of equity compensation awards commonly used by start-up companies and an explanation of the reasons why certain types of awards are used at various stages of development. The article discusses the basic characteristics, federal tax consequences, accounting treatment and ad­vantages and disadvantages of granting these types of equity awards.