Why a Successful Equity Strategy Requires Advanced Planning – Stripe as Case Study
Or Golod Barzilay| Mar 23, 2023
When early-stage companies set a policy on offering equity shares to prospective employees, they hope it will attract top talent and motivate employees. They don’t anticipate the plans becoming tax burdens for employees or expiring before they can benefit from them, causing frustration rather than motivation.
But that’s the reality for several late-stage tech companies these days, most notably the payments giant, Stripe.
Like many companies that anticipated an imminent IPO, Stripe made the well-meaning decision to issue Restricted Stock Units (RSUs) to employees. It was a reasonable decision at the time since RSUs, unlike stock options, don’t require employees to pay a price to exercise the options into underlying shares. They automatically belong to the employees when they vest, with the vesting schedule usually being time-based according to the term of employment.
But since the recent market downturn, Stripe and others have delayed their IPO. As a result, some RSUs have vested, leaving employees with a tax bill of 22%-37% of their value – but with no way to sell the stocks without a liquidity event such as an IPO. The problem is compounded by the fact that the RSUs Stripe issued expire after seven years if there is no liquidation event.
The delay in the IPO means employees will have been taxed on shares they never had a chance to sell.
To offset the potential hardship on its employees, Stripe is scrabbling to cover the taxes by selling off some of the shares to investors (known as a secondary transaction) and using the money to cover the massive tax bill its employees face – as much as $4 billion total. It’s a strategy that might not be available to other companies, at least some of which will have to find ways to assuage employee discontent. Failing to do so can breed distrust in the company’s policies and deter top talent instead of attracting it.
The plight of Stripe and other late-stage companies that offered RSUs but are now putting off IPOs highlights the critical importance of strategizing stock awards carefully from the outset.
RSUs are only one of the many financial instruments that can be granted to employees. Private companies must carefully consider the pros and cons of granting RSUs vs. granting options to arrive at an optimal strategy for their business – and be aware of any eventual ramifications.
RSUs vs. Stock Options
In the tech world, companies routinely offer equity to make job offers more appealing. As a non-cash benefit, equity increases the offer’s value without dipping into working capital. Equity aligns everyone’s interests and motivates high achievement, so everyone benefits from the company’s success.
While there are different equity packages, companies typically offer two types – RSUs and stock options. In general, private companies in the early stage are likely to offer stock options, whereas public companies and, in some cases, late-stage private companies offer RSUs.
Here is a brief description of each option and a list of their primary advantages and disadvantages.
There are different kinds of stock options (NQSOP, ISO, ESOP), but in general, what sets them apart from RSUs is that they are, as the name indicates, “options” to purchase a set number of company shares at a pre-set price known as the “strike” price.
The owner of the options does not incur any tax obligation when the options vest, typically through time (though some vest by achieving incentives). Owners of stock options are taxed in most locations only if they exercise the stocks into shares. Depending on the location, those who exercise the options are often charged income tax at the time of exercise and capital gains tax on the profit when they sell the shares.
The advantages of offering stock options include the fact that there are no taxes until the options are exercised and that their gradual vesting process, usually every quarter, encourages employees to stay with your company longer to gain more options.
The disadvantages are that they are not stocks in themselves but rather an option to buy stock (the employees pay to purchase the actual stocks.) In addition, the options’ value (when the employee exercises them) must be above the strike price for the options to have an immediate positive value.
Restricted Stock Units (RSUs)
RSUs are essentially a promise from a company to an employee to grant a certain amount of stock at a certain time or under certain conditions. Once those conditions have been met, the stocks are granted to the employee with no need to pay an exercise price. This process takes place automatically at vesting and immediately triggers a tax obligation for the employee.
To cover employee taxes, public companies can use a mechanism called sell to cover.
The company sells a portion of the vested RSUs at the fair market value to cover the taxes. The employee will end up with a smaller number of shares but will own them outright with no taxes or outlay to purchase them.
For private companies, the sell-to-cover mechanism is more difficult because the RSUs have no known fair market value (though in some cases, a 409A valuation can be used). To protect employees from the type of bind currently taking place at Stripe – where they pay income tax but have no ability to sell the stocks – private companies can impose a double trigger. Double Trigger RSUs are taxed only if two requirements are met. First, the stocks have to vest, just like regular RSUs. Second, they transfer to the employee when there is a liquidity event, such as an IPO.
The advantage of offering RSUs is that employees don’t have to pay for the stocks they receive and public companies have mechanisms in place to offset taxes so employees don’t actually bear the taxes at vesting.
The primary disadvantage is that vesting could result in a tax bill for private employees if there is no liquidation event or double trigger. In addition, some forms of RSUs, such as Stripe’s, expire in seven years unless the company purchases the shares or goes to IPO (though some RSUs do not – another detail that must be clarified from the outset).
Look Before You Leap – Essential Considerations
Although equity offers are strongly associated with the tech world, companies in all sectors offer equity, especially when hiring for senior positions. But global equity plans can be enormously complex to manage.
Equity is a highly regulated space, with different tax laws, securities compliance, and labor laws in every country. Without a tax lawyer, CPA, or tax advisor in each location, companies could face heavy fines for non-compliance.
Papaya Global’s team of equity experts and local partners work with you to structure and implement an equity plan for a global offering and account for local regulatory and tax requirements suited to the type of equity you grant and where you grant it.
The equity process begins prior to onboarding and continues throughout the grant’s lifecycle. Building an effective equity plan starts by considering the following areas:
Taxable events and how to calculate them – Different awards trigger tax events at different times, depending on the local regulations.
Taxation in different countries – Equity is taxed differently in every country, both in terms of the tax rates and how the taxes are administered. In some countries, equity is taxed when it is granted to the employee. Other countries only tax the profits when the shares are sold. Consult with an expert to avoid fines for non-compliance.
Reporting requirements – Reporting requirements could include filing the right forms with local tax authorities and disclosing information at the proper time to investors, securities commissions, and regulators. It is essential to know the reporting requirements for your country and the type of equity at the start to ensure that all information is collected properly in local compliance.
Necessary obligations for the EoR to report in different regions – It’s possible to grant equity to your entire global team, including those employed through an Employer of Record (EoR). Since the team members are hired by a local company, not the granting company issuing shares, the process is more complex. We work closely with vetted EoR partners in each location to ensure all taxes are withheld, and reporting is done compliantly.
Stage of growth – While most equity planning takes place at the earliest stages of a company’s development, important decisions about equity strategy take place in later stages as well. A company might start with a plan to offer stock options, but as it begins planning for an IPO, it might consider adding RSUs as well, particularly as it looks to attract highly professional talents. Each stage requires advanced planning.
Papaya’s equity experts can guide you through all of the essential questions, including the taxable events you are going to encounter in each location, how to calculate them, and how to meet your reporting requirements in over 160 countries.
Contact us to learn more about how Papaya can help you structure your global equity plan.
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