By Gregory M. Prekupec & Rahul Gupta
Introduction
Employees are often offered shares in their employer as part of the employee’s overall compensation. There are a variety of benefits of doing so, including aligning the motivations of the employees with the shareholders, rewarding an employee’s historical performance, or to encourage future performance and behaviour.
Equity compensation can take a variety of forms, including stock options, restricted share units, deferred share units, share appreciate rights, and phantom share plans. Such form of compensation is applicable to public and private corporations alike, with public corporations having greater prescribed requirements under the rules of the various stock exchanges.
Security Law and M&A Considerations
Generally speaking, equity issuances to grantees (defined below) are generally exempt from prospectus requirements, assuming the satisfaction of certain criteria by the grantor.
Upon the sale of a grantor (defined below), the purchaser may wish to cash out the majority of the outstanding awards or to assume the award structure and substitute the grantor’s shares with its own.
Common Forms of Equity Compensation
As mentioned above, equity compensation can take various forms. However, common forms include:
A. Stock options;
B. Restricted share units;
C. Performance share units;
D. Phantom share plans;
E. Deferred share units;
F. Share appreciation rights; and
G. Employee share purchase plans
Stock Options
A stock option is when an employer (the “grantor”) provides an employee, independent contractor, or other service provider (the “grantee”) with the right, but not the requirement, to purchase shares, or other securities from the grantor at a specified strike price within a certain time frame.
A. Strike Price
A strike price is a fixed price at which the grantee can buy or sell the underlying security. In the case of equity compensation, the grantor will likely provide the strike price of the fair market value of the shares at the time the stock options are provided. In a private corporation, the strike price may be lower than the fair market value of the shares if the grantor’s constating documents allow for the same.
B. Term and Vesting Schedule
Grantors tend to provide a date by which the grantees may exercise their options, which may be 5-10 years after the option is provided.
On the other hand, grantors also want to ensure grantees do not exercise such options and then immediately change jobs. Accordingly, stock options must “vest” which means the grantee must work for a specified time frame or achieve certain performance criteria before the grantee can exercise the option.
Options are typically structured such that they all vest at the end of a certain period or in segments over such period. These options may accelerate due to the occurrence of a particular event such as an initial public offering, the sale of the grantor, or the grantee’s termination of employment.
C. Stock Option Plans
Due to the frequency of stock options being issued, grantors typically issue a stock option plan which allow for a series of grants to the grantees. Such plans can vary on a variety of factors, including but not limited to, the size of the grantor, the liquidity of the grantor’s shares, tax considerations, size of the executive body of the grantor, etc.
Stock option plans are usually discretionary to limit the grantor’s liability under such plan. They also can be granted to independent contractors and other service providers, each carrying their distinct tax considerations
Restricted Share Units; Performance Share Units; Deferred Share Units
A restricted share unit (“RSU”) is a conditional right to receive shares or cash without a purchase or strike price. Accordingly, the RSU holder does not actually hold any equity in the grantor, and is therefore not entitled to any voting, dividend, or other rights unless the RSUs are settled in shares. On the other hand, performance share units (“PSU”) are subject to performance based vesting schedules (e.g., the revenue growth of the grantor over a three-year period).
A deferred share unit (“DSU”) is the right to receive cash or shares of the grantor within 1 year of the grantee’s retirement, termination, or death.
PSPs, RSUs, PSUs, and DSUs are all offered on a discretionary basis and grantors are not required to have uniform offerings amongst grantees. In addition, these plans can also be extended to non-employee grantees, each carrying their own tax treatment.
Phantom Share Plans
A phantom share plan (“PSP”) is connected to grantor shares; however, the grantee is not actually issued shares. Rather, the grantee receives access to an account which is credited with hypothetical shares, and the corresponding hypothetical dividends and appreciation (if any). Upon the culmination of the vesting schedule, the grantees are awarded with the phantom account value in cash or shares.
The key differentiator between PSPs and stock option plans is they do not need to be exercised by the grantee as they are settled automatically.
Share Appreciation Rights
Share appreciation rights (“SAR”) are rights afforded to grantees to receive the appreciation of the value of underlying shares in cash over the vesting period. When SARs are offered together with other forms of equity compensation, a grantee can exercise their options and acquire additional shares instead of only receiving cash settlement.
Employee Share Purchase Plans
An Employee Share Purchase Plan (“ESPP”) allows grantees to acquire shares of the grantor per certain time frames at a prescribed price. A grantor can restrict the ESPP as they wish however, grantors usually offer grantees financial assistance such as low-interest loans or matching payments. Private corporations often require grantees under ESPPs enter into a unanimous shareholder agreement as to not affect the management of the grantor.
Concluding Thoughts
Equity compensation continues to be a valuable tool for private corporations seeking to attract, retain, and motivate talent while aligning employee interests with the long-term success of the business. Whether through stock options, RSUs, SARs, or phantom share plans, each structure offers unique benefits and legal considerations for both employers and grantees. As equity-based incentives grow increasingly sophisticated, it is important for corporations to carefully tailor these plans to their operational needs, tax objectives, and corporate governance frameworks. Thoughtful implementation, clear documentation, and ongoing legal guidance are key to maximizing the value of equity compensation while minimizing associated risks.