Equity incentive plan: Overview, definition, and example
What is an equity incentive plan?
An equity incentive plan is a compensation strategy used by companies to attract, retain, and motivate employees by offering them ownership or stock-related benefits in the company. These plans provide employees with the opportunity to receive company stock or stock options as part of their compensation package, which aligns their interests with the company's success. Equity incentive plans are often used by startups and growing businesses to reward employees for their contribution to the company's growth and to incentivize them to work towards increasing the company's value.
Equity incentive plans may include stock options, restricted stock units (RSUs), performance shares, or stock appreciation rights (SARs), all of which allow employees to benefit from the company’s financial growth.
Why is an equity incentive plan important?
An equity incentive plan is important because it helps companies motivate and retain key employees by providing them with a financial interest in the company's success. When employees have an ownership stake, they are more likely to be invested in the company’s performance and long-term growth, as their personal financial gain is tied to the company's success. For companies, an equity incentive plan offers an attractive compensation tool, especially when cash resources are limited or when they want to foster a culture of ownership and commitment.
For employees, these plans offer an opportunity to benefit from potential company growth, either through stock appreciation or dividends, and can be a significant part of their overall compensation package.
Understanding equity incentive plan through an example
Imagine a technology startup that is looking to retain its top engineers. The company sets up an equity incentive plan that offers stock options to employees, allowing them to purchase company stock at a set price after a certain vesting period (e.g., 4 years). If the company grows and its stock value increases, the employees can exercise their options at the predetermined price, benefiting from the stock’s appreciation.
In another example, a publicly traded company might offer restricted stock units (RSUs) as part of its equity incentive plan. Employees are granted a certain number of RSUs, but they do not receive the shares immediately. The RSUs vest over time (e.g., 3 years), and once they are vested, the employees can receive company stock. If the company performs well and its stock price increases, the employees benefit from the appreciation.
An example of an equity incentive plan clause
Here’s how a clause like this might appear in a company’s compensation policy or stock option agreement:
“The Company will establish an equity incentive plan for eligible employees, which may include stock options, restricted stock units, or other equity-based compensation, with the aim of aligning employee interests with the long-term performance and success of the Company. The Plan will be administered by the Compensation Committee, and all awards will be subject to vesting schedules, performance conditions, and other terms as set forth in the Plan document.”
Conclusion
An equity incentive plan is a powerful tool used by companies to motivate and retain employees by offering them an ownership stake in the company. By linking employee compensation to the company's performance, these plans create a sense of shared purpose and alignment with the company’s success. For employees, equity incentive plans can provide the potential for significant financial rewards through stock options or stock grants, particularly if the company experiences growth. For companies, these plans serve as a cost-effective method to incentivize and retain talent, especially when cash compensation might be limited.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.