# Equity compensation Author: Josh Steinfeld Read time: 5 minutes Published date: 13 March 2024 Equity compensation is a non-cash part of overall compensation and benefits. Learn the different types of equity startup leaders can offer to their teams. Contents: Download tax reporting requirements for issuing equity ## What is equity compensation? Equity compensation is a non-cash part of [overall compensation](https://fund-forecasting@carta.com/sg/en/learn/startups/compensation/) and benefits, offering employees and other service providers an ownership stake in the company they’re working for. Equity-based compensation could include [stock options](https://fund-forecasting@carta.com/sg/en/learn/equity/stock-options/) or [restricted stock units](https://fund-forecasting@carta.com/sg/en/learn/equity/rsu/) and may be given to [advisors](https://fund-forecasting@carta.com/sg/en/learn/startups/equity-management/advisory-shares/), [investors](https://fund-forecasting@carta.com/sg/en/learn/startups/fundraising/investors/), or other contributors in addition to employees. Company stock can appreciate as your business grows. By offering equity, you can align recipients’ interests with the business’s success. This type of compensation can also help attract and retain talent when cash flow might be tight in your startup’s early days. ## How does equity compensation work? A paycheck is pretty self-explanatory, but equity compensation plans can be more complex. ### 1. Equity grant A [grant](https://fund-forecasting@carta.com/sg/en/learn/equity/stock-options/stock-grant/) is a document that you give to your employees or other service providers as part of their compensation. It will have important information like: - the grant date - how many stock options / the number of shares being granted - the [fair market value (FMV)](https://fund-forecasting@carta.com/sg/en/learn/startups/equity-management/fmv/) of the shares / the exercise price - the vesting schedule or other vesting requirements Recipients will need all of this information to make informed decisions about their equity—like whether to exercise their options or sell shares—and for tax treatment information. ### 2. Vesting [Vesting](https://fund-forecasting@carta.com/sg/en/learn/equity/stock-options/vesting/) is the process of earning equity over a period of time or via predetermined benchmarks like hitting performance metrics. The most common vesting schedule is a grant that vests over four years with a one-year cliff. That means the recipient wouldn’t earn any of their equity unless they stay at the company for a year; to receive all shares, they’d have to stay for all four years. Vesting periods like this can help ensure employee retention for a certain amount of time. ### 3. Exercising Granting stock options grants _the right to buy_ shares at a previously agreed-upon price, known as the exercise or [strike price](https://fund-forecasting@carta.com/sg/en/learn/equity/stock-options/strike-price/). A stock option grant _does not_ automatically issue any equity. Recipients of stock options must [exercise their options](https://fund-forecasting@carta.com/sg/en/learn/equity/stock-options/exercising/) (aka buy the shares) to actually own shares in a company. In most cases, option holders can only exercise their options after vesting conditions are met. But, some companies allow [early exercising](https://fund-forecasting@carta.com/sg/en/learn/equity/stock-options/exercising/early-exercise/), which allows stockholders to buy options before they vest. ### 4. Taxes on equity compensation Tax implications for employee equity vary widely based on equity type ( [ISOs vs. NSOs](https://fund-forecasting@carta.com/sg/en/learn/equity/stock-options/taxes/) for options, for example). [Get tax reporting guide](https://fund-forecasting@carta.com/sg/en/learn/equity/compensation/#download-tax-reporting-requirements-for-issuing-equity) Companies who use [Carta for cap table management](https://fund-forecasting@carta.com/sg/en/equity-management/cap-table/) can take advantage of easy access to expert tax advice for their employees. ### Different types of equity compensation #### 1. Stock options: ISOs and NSOs There are two [types of stock options](https://fund-forecasting@carta.com/sg/en/learn/equity/stock-options/): ISOs (incentive stock options) and NSOs (non-qualified stock options). - **ISOs:** [Incentive stock options](https://fund-forecasting@carta.com/sg/en/learn/equity/stock-options/iso/) are only available to employees and offer potential tax benefits (like not having to pay taxes when exercised unless the AMT is triggered). - **NSOs:** [Non-qualified stock options](https://fund-forecasting@carta.com/sg/en/learn/equity/stock-options/nso/) can be issued to employees or non-employees, including consultants or contractors. NSO holders will owe income taxes when they exercise their options. #### 2. Restricted stock units (RSUs) and restricted stock awards (RSAs) Unlike stock options, which must be exercised first, with [RSAs and RSUs](https://fund-forecasting@carta.com/sg/en/learn/equity/rsa-vs-rsu/), you’re the legal owner of the shares when they’re issued to you. The question of when you receive those shares depends on if you have RSUs or RSAs. - **RSAs:** You own the shares when you accept your grant and meet any purchase price requirements, but they’re still subject to vesting conditions. - **RSUs:** You get the right to acquire shares of [common stock](https://fund-forecasting@carta.com/sg/en/learn/equity/common-stock-vs-preferred-stock/) if certain conditions are met—often a vesting schedule and/or a [liquidity event](https://fund-forecasting@carta.com/sg/en/learn/equity/liquidity-events/) for the company. You generally don’t have to pay anything to acquire these shares, besides taxes. But, the FMV of your vested RSUs will be treated as compensation. #### 3. Equity incentive plans for LLCs Equity compensation for [limited liability companies (LLC)](https://fund-forecasting@carta.com/sg/en/learn/startups/private-companies/llc/) is different from corporations. The biggest differences between equity compensation options for these types of entities include taxation, voting rights, and employee status. ##### Phantom equity Similar to a bonus, [phantom equity](https://fund-forecasting@carta.com/sg/en/learn/startups/compensation/equity-incentive-plans/phantom-equity/) gives holders a cash payout when the [company is acquired](https://fund-forecasting@carta.com/sg/en/learn/startups/exit-strategies/mergers-acquisitions/) or goes public. ##### Profits Interest Units (PIUs) [Profits interest units](https://fund-forecasting@carta.com/sg/en/learn/startups/compensation/equity-incentive-plans/profits-interest/) are the most common type of equity offered by LLCs, allowing members a share in future profits and growth, aligning member interests with long-term success. #### 4. Employee stock purchase plans (ESPPs) [ESPPs](https://fund-forecasting@carta.com/sg/en/learn/equity/espp/) enable employees at public companies to buy shares often at a discount, through post-tax payroll deductions over a specific offering period. ## Build a sustainable equity compensation strategy with Carta Total Compensation [Carta Total Compensation](https://fund-forecasting@carta.com/sg/en/equity-management/compensation/) has the largest set of private company equity data. Learn more about Carta Total Compensation [here](https://fund-forecasting@carta.com/sg/en/equity-management/compensation/). ## Download tax reporting requirements for issuing equity Check out our visual, step-by-step guide for understanding when and how to report taxes related to your stakeholders’ ISOs, NSOs, RSUs, and RSAs.