Equity versus salary: an overview
Startups are known to be relatively cash-strapped and prefer to reduce payments to employees considering their need to conserve cash and recycle any cash they generate in their business operations. They often offer equity compensation as a result.
Instead, the advantage of receiving a salary is that you know exactly what you are getting. It is a fixed sum that you can count on and plan for your future. Of course, you will still be subject to the risk that your employer will go out of business or your employment may be terminated, but wages offer much more security than general equity compensation.
Equity compensation often goes hand in hand with a below-market salary. They are not necessarily mutually exclusive.
- Equity is often promised along with a lower-than-market salary. It is not always completely one or the other situation.
- Equity compensation generally has a consolidation schedule, which means that you will only own your capital after a certain period of time. It is not tied to the company in the same way with the payment of salary.
- The tax implications of capital gains can be much more complex than wage gains.
The main risk associated with offsetting stocks is that you are not guaranteed to benefit from your capital appreciation. Too many variables can influence the profitability of your equity stake.
First, the startup will have to succeed, and many fail and go bankrupt. Consider how the dot-com bubble burst in 2000, leaving those offered stock options high and dry.
Equity compensation generally has a consolidation schedule, which means that you will only own your capital after a period of time. In the meantime, you will be tied to the company as you watch your stock payment pay off.You could lose your bet if you are fired from work.
There are a variety of ways to structure principal payments, each with its own advantages and disadvantages. It could be offset in the form of incentive stock options (ISO) or restricted stock units (RSU).
You are not tied to the company in the same way when you earn a salary, and you keep what you earn when you earn it. But most large companies in any industry impose salary range structures or pay grades, that limit is the most you can earn, even after several years of service. Some senior executive positions may be exempt from this rule. With that said, someone who is just starting out can feel pretty confident that their salary will increase over time. Get the job done and there’s little risk involved.
According to the Bureau of Labor Statistics (BLS), “information systems managers“They are on the list of the 20 highest-paid professions, but they are ranked 16th on the list. The somewhat vague category of” CEOs “ranks 10. Most of the highest paid salaries are for those in fields. Doctors, and all of these rankings are for those at the top of their games.
Example of equity versus salary
You have the potential to get a big payout with options if your business does it succeed. You could even get rich if your company comes out with a successful initial public offering. This is how some of the early employees of companies like Google (GOOG) and Facebook, Inc. became millionaires.
There is no such potential for a big pay down the road if you are earning a salary; you will have to invest your income to generate an additional return.
You may find yourself in a hole after paying capital income taxes, even though you technically got through. You may owe taxes even if your share price dropped after you exercised your options and owned your shares. This introduces another element of risk. It’s important to exercise your stock options at the right time and opportunistically charge for the shares you get so that you can generate a real return rather than a paper return.
Each form of compensation has different tax consequences. It is important to know exactly how your employer is structuring your capital compensation because you could end up with a considerably higher payment depending on the form of compensation and the size of your stake in the company.Paying a salary doesn’t involve that kind of complex structure, except perhaps to negotiate the timing of any bonuses for tax planning purposes.