Pros & Cons of Stock-Based Compensation | Green Associates

The Pros and Cons of Stock-Based Compensation

Financial AdviceDecember 06, 2022

You may have heard the terms ‘stock-based compensation’ and ‘equity compensation’ thrown around, especially as an increasing number of Australian employers are offering Employee Share Schemes.

You may have heard the terms ‘stock-based compensation’ and ‘equity compensation’ thrown around, especially as an increasing number of Australian employers are offering Employee Share Schemes.

Learn the basics of stock-based compensation below and find answers to some of the frequently asked questions we receive at Green Associates.   

  

What is stock-based compensation?

Also known as shared-based and equity compensation, stock-based compensation is when a company pays its employees and directors with equity; a financial share in the company.  

  

What are the types of stock-based compensation?

The types of equity used as stock-based compensation include:  

  • Shares at a discounted price  
  • Stock options – options to purchase stocks at a certain time and price. The employee doesn’t own the shares until they exercise the option.   
  • Employee Share Schemes (ESS) – a way for companies to provide benefits to their employees through the grant of stocks now or stock options  
  • Restricted Share Units (RSUs) – grant of stocks but the employee does not own the shares until after a vesting period.   

   

How do RSUs work?

 RSUs give you a future share of the company. You don’t actually own them until after the vesting period, which is typically 3-5 years.   

Over this period, there might be a distribution schedule such as 1/5th of the total shares per year over 5 years. Once vested, the employee can choose to sell to convert to cash or hold the shares.   

  

How does an ESS work?

Also known as an employee share purchase plan or equity scheme, an ESS allows you to buy shares in your company at a discount. You can do so with an upfront payment, through salary sacrifice or using dividends on existing shares. Your ESS might also stipulate that you can receive shares as a performance bonus.  

  

What are the tax implications of stock-based compensation?

There are several tax concessions and conditions to consider.  

  • The discount received must be reflected on your tax return.  
  • If you received your shares under a taxed-upfront scheme, you might be eligible for a $1,000 reduction if your taxable income after adjustments is less than $180,000.  
  • Once RSUs are vested, the shares are considered income and income tax must be paid.   
  • Capital gains tax is also payable when you sell your shares. In Australia, the capital gains tax is 30%.  

It’s crucial that you’re aware that stock-based compensation can also move you into a higher tax bracket. Book an appointment with your Greens Associates financial adviser for taxation advice to ensure that exercising your options doesn’t just increase your tax bill. Your adviser can also generally give you clarity on tax treatment of stock-based compensation.  

  

What are the advantages and disadvantages of stock-based compensation?

Pros

  • For your employer, stock-based compensation doesn’t require cash, aligns the interest of employees and shareholders and incentivises for employees to stay with the company. 
  • For you as the employee, you can directly share in the business success that you’ve helped create.  
  • Stock-based compensation can form an integral part of your long-term investment strategy; it can help you diversify your portfolio at a lower cost as you might not have to pay brokerage fees.   
  • You may also receive tax benefits from equity compensation, depending on the scheme and your financial position.    

 

Cons  

  • You must effectively rely on others to also put in the work to drive up company results and performance.   
  • There may be limitations on when you can actually buy and sell the shares.  
  • For all shareholders (including you), ownership is diluted each time more shares are issued.  
  • If the company’s share price falls, stock-based compensation is no longer attractive as you are losing money.  
  • In addition, options are difficult to value and there are administrative costs with stock-based compensation that add up.  

Is your company offering stock-based compensation?

Your Greens Associate financial adviser and planner can help create a financial plan that considers this and leverages it to achieve your overall goals. With specialists in Canberra, Brisbane and Goulburn, book an appointment today.

Your Greens Associate financial adviser and planner can help create a financial plan that considers this and leverages it to achieve your overall goals. With specialists in Canberra, Brisbane and Goulburn, book an appointment today.

What happens to my RSUs if I am fired or if I leave?

You will only keep the shares that are already fully vested. As an example, if your shares were vested at a schedule of 1/5th every year and you leave in the 4th year, you’ll lose the last-fifth of the shares that were going to be fully vested.  

  

What about shares that I already own – what happens if I am fired or if I leave?

This depends on the terms and conditions of the offer. One term could be that once you leave, you have to sell your shares and pay extra tax. It’s important that you understand all the features of your ESS before you enter it. Consider getting financial advice from Greens Associates before you sign up.  

  

Will I have all shareholder rights?

Again, this depends on the terms and conditions of the offer. You might be issued ordinary shares with rights like voting, or you might receive dividends only.   

  

What if the shares fall in value or my company goes out of business?

You’ll likely be unable to sell your shares and options could be suspended. You can record a capital loss on your tax return to offset future capital gains and reduce your tax bill. You might also be eligible for some tax benefits. It is a complex situation and consulting with your Greens Associates Financial Advisor is highly recommended.   

  

 

Need more advice that’s personalised to your financial position and plan? Speak to our knowledgeable, friendly team on 1300 815 921 or info@greenassociates.com.au  

 At Green Associates, all of our advisers are fully licensed and listed on the ASIC Moneysmart Financial Adviser Register. Green Associates is committed to providing the best solutions for you and your wealth-creation journey.  

Written by

Stuart Holden

Financial Advisor | Director

Learn More