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Not only does Brown Wealth Management share our San Diego home with some of the most innovative companies in the nation including Qualcomm, Illumina, ViaSat, but we continue to see a huge expansion of start-ups and tech companies popping up around the county. And while an up-and-coming tech company typically requires the expertise of programmers, marketers, developers and more highly talented, qualified individuals, it can’t always afford the five- or six-figure salaries these employees have come to expect. In many cases, these start-ups will turn to a different option for employees: equity compensation. Below we’re outlining what equity compensation is and how it compares to its more traditionally used counterpart.
What Is Equity Compensation?
Equity compensation is compensation for employees in the form of a share of the company’s future profits. This could be through various stock options and/or performance shares, or whatever other arrangements the individual company has decided on.
Tech companies, especially when they’re just starting out, may not have the cash flow needed to cover the salaries of their employees. But, of course, they recognize the need for incentivizing and encouraging highly motivated individuals to join their team. That’s why some tech companies turn to equity compensation. Typically, this will be offered either in conjunction with a below-market salary offer, or no salary at all.
Pros of Equity Compensation
Being offered a portion of your company’s future profits is an exciting opportunity for workers and an important incentive for loyal employees to stick with one company for many years. Dependent on the success of the company, there’s an opportunity for these stock options to provide a bigger payout than a standard salary would.
Risks of Equity Compensation
But as is with any stock option, where there’s a chance for reward, there’s a risk as well. Compensation via stocks or other equity compensation could leave employees’ pay at the mercy of the market and the company’s performance. And while this is a risk that many understood when agreeing to the terms of their compensation, it can be hard to remember nothing is guaranteed.
In fact, it’s not entirely uncommon for tech industry employees to experience lifestyle creep, which is a rise in spending or standard of living paralleled with a rise in income, only to feel the crash hardest when their stock options perform poorly. You can read more about strategies for concentrated holdings here.
Additionally, it’s important for employees to understand the potential tax implications that equity compensation may have on their future earnings. These implications will vary dependent on the structure and specifics of the company offering the compensation. But in some cases, cashing out on your stock options may look like a big payout on paper, but taxes could be taking a sizeable chunk out of the check you were expecting to receive.
What Is Salary Compensation?
More commonly used throughout the rest of the workforce, salary compensation refers to the base pay one receives based on a predetermined hourly, weekly, monthly or yearly figure. With most salaries, you know exactly how much you are receiving and the number does not fluctuate based on the profits or losses of the company.
Pros of Salary Compensation
In a word: dependable. Every pay period, you know exactly how much you’re going to receive. This makes salary compensation a steady, dependable form of payment that allows you to plan ahead for future spending, saving, etc. because you know how much you can count on receiving on a regular basis.
Risks of Salary Compensation
While dependability is an obvious advantage of salary compensation, it can be considered a disadvantage as well. Why? Because with a salary, there’s really no chance for a greater payout than what you’re already earning. The only way to potentially earn more in this scenario is to take your paycheck and invest it on your own. In addition, pay grades and salary structures can mean you’re capped out at earning a certain amount. And, of course, there is still the risk of job layoffs or a company going under.
Joining the tech industry is an exciting opportunity for talented, dedicated individuals across the country. But as you navigate your compensation options, it’s important to remember both the risks and rewards of equity and salary compensation.
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