Common Types of Equity Compensation

1. Overview

Equity compensation is a way for companies to reward employees by giving them ownership in the company. Instead of just paying cash, companies offer shares or the chance to buy shares in the future. This helps employees benefit when the company grows in value.

However, there are different types of equity compensation, with each working a little different depending on your location, company type, and role. So how would you know the type of equity compensation that you are qualified to receive?

2. Equity Compensation Around The World

As mentioned in the previous articles, despite ESOP being a type of equity compensation, the term has a slightly different meaning in both Asia and the United States.

In Asia, the term “ESOP” is often used loosely to describe any kind of stock-based compensation — including options and RSUs.

In the United States, “ESOP” has a much more specific legal meaning: it refers to a retirement plan where the company contributes shares to a trust for employees.

In this guide, we’ll treat ESOPs, RSUs, Stock Options, and SARs as separate types, so you can understand which one you have and what it means for you.

3. Employee Stock Ownership Plan (ESOP)

An ESOP is a way for companies to reward employees with shares in the company, typically at no cost to you. In Asia, “ESOP” is used as a broad term for stock rewards where employees receive the shares over time (called vesting, which we will cover in another article) and may only fully own them after staying with the company for a few years.

In the United States, ESOP is referred as a formal retirement plan, where a company sets up a trust and contributes shares to it on behalf of employees. You don’t buy these shares, but it is given as part of a long-term benefit. The catch is that these shares may not be immediately accessible, and the plan is usually designed to reward employees who stay for many years.

In short: ESOPs give you ownership in the company but usually come with waiting periods and some restrictions on when you can sell or access the shares.

4. Restricted Stock Units (RSU)

Restricted Stock Units are one of the simplest and most common forms of equity compensation. When you receive RSUs, the company promises to give you actual shares of stock, but only after you meet certain conditions.

These conditions may vary, such as staying with the company for a set period, or in some cases, meet specific performance targets.

A huge benefit of RSU is that you don’t have to pay anything to receive it. Once they vest, they will become real shares in your name, where at that point, are usually considered as taxable income — though the exact tax treatment depends on your country’s laws.

RSUs are popular because they’re easy to understand. Technically, you’re getting shares fore free if you stay long enough, but the caveat is you usually do not have control over when they’re delivered, and you typically won’t have voting rights until the shares are fully vested.

In short: RSUs are like a delayed gift of a company stock. While you don’t have to pay for it, you must meet certain criteria to receive them.

5. Stock Options (NSO/ISO)

Stock Options gives you the right to buy company shares later at a fixed price (called the exercise or strike price). The goal is simple: if the company’s value increases, you can buy shares at the lower set price and potentially sell them for a profit. But there’s a risk — if the company’s value doesn’t rise above your exercise price, the option might not be worth anything at all.

There are two main types of stock options:

1. Non-qualified Stock Options (NSOs): NSOs can be given to any employee, including outside consultants, and are used both in Asia and the United States.
   
   
2. Incentive Stock Options (ISOs): ISOs are a US-only stock option with special tax benefits. This compensation is given only to US-based employees, where if certain holding requirements are met, ISOs may be taxed at a lower capital gains rate instead of as ordinary income.
   
   

In short: Options give you the chance to profit from the company’s growth, but require you to buy the shares and come with more risk and complexity.

6. Stock Appreciation Rights (SARs)

Stock Appreciation Rights, or SARs, lets you benefit from the company’s stock price increase without actually owning the shares. If the stock goes up, you get paid the difference between the starting price and its current value in either cash or in shares.

The concept of SARs is simply. You don’t need to pay anything upfront, or buy any shares, but that means you don’t get any real ownership or voting rights like how shares normally work.

So why do companies issue SARs anyways? Well, it is often used by companies that want to reward employees based on performance without giving away equity. SARs are more common in the US than in Asia, and are especially popular in companies that are cautious about share dilution or managing share pools.

In short: SARs gives you the benefit of a stock price increase without requiring you to buy or own the stock.