What is Equity Compensation in an Organisation?
- 30th January 2026
- 02:00 PM
- 7 min read
Equity compensation is a type of non-cash remuneration that companies provide to their executives, employees, and even directors, if compensation is tied to their equity.
To retain talent, numerous fast-growing startups offer equity compensation. As per the Economic Times, median compensation for engineering roles in India dropped 40% to USD 22,000 in 2025 from USD 36,000 in 2024.
This blog provides a comprehensive guide on what is equity compensation, its different types, benefits, and limitations.
What Does Equity Compensation Mean?
Equity compensation is a type of non-cash payment that an organisation offers to its personnel as partial ownership in the business. Employees who get equity compensation might share the company’s profits through appreciation.
A lot of startups use equity compensation as a strategy in their growth phase, which may need a substantial amount of their working capital to invest in business expansion.
What are the Different Types of Equity Compensation?
-
Stock Options
Stock options grant the employees the right to buy company stock at a fixed price within a particular time frame. If the stock price increases, employees may exercise their options, buy shares at the lower price, and sell them to earn a profit.
-
Non-Qualified Stock Options (NSOs) and Incentive Stock Options (ISOs)
NSO and ISO are some other types of equity compensation. For NSOs, employers do not have to report when they get this option. In ISOs, only employees get special tax advantages, and non-employee directors are not included in this.
-
Restricted Stock Units (RSUs)
Restricted stock units show a company’s commitment to pay shares according to a vesting schedule. While it provides benefits to the company, it does not grant any ownership rights to the employees until they earn the shares.
-
Performance Shares
Performance shares are granted to employees when they achieve specific performance goals. These are revenue targets or earnings per share (EPS) thresholds.
-
Employee Stock Purchase Plans (ESPPs)
ESPPs allow employees to buy the company stock at a comparatively lower price through payroll deductions for a particular offering period. This may provide an opportunity for employees to invest in the company at favourable terms.
Advantages of Equity Compensation
| Benefits | Employees | Employers |
| Financing Strategy | Not applicable for employees | Helps startups compensate for new talent who do not have adequate capital to compensate for their new talent |
| Alignment of Interest | Employees become the company’s stakeholders. | Stock options align the employees with a company’s goals. Employees feel more driven to work for the company’s growth. |
| Talent Retention and Attraction | Not applicable for employees | Equity compensation helps employers attract and retain top talent, especially in competitive sectors. |
| Tax Benefits | Employees can delay taxes until they sell the equities. | Companies may benefit from tax deductions depending on the expense considered for equity compensation. |
Disadvantages or Risks of Equity Compensation
-
Market Volatility
Market fluctuations can impact the value of equity compensation, which can create employee dissatisfaction if stock prices drop significantly. This can affect the perceived value of their compensation.
-
Complex Valuation
Valuing equity compensation can be difficult to understand. This complexity can lead to problems in accurately estimating the cost of equity compensation.
-
Dilution of Ownership
New share issuance to employees may dilute the ownership percentage of existing shareholders. It can be a concern for the present investors.
-
Vesting Requirements
Equity compensation typically requires employees to stay with the company for a particular period to earn their shares. These vesting requirements can create frustration if the employees leave before vesting is completed.
Taxation of Equity Compensation
-
Restricted Stock Units
Upon RSUs vesting and share delivery, employees recognise income and incur tax liability, as per the shares’ present fair market value.
-
Stock Options
Employees do not incur taxes on the granting of a stock option and may owe taxes after exercising the options and purchasing or selling the shares.
-
Performance Shares
Just like RSUs, taxes are incurred on vesting once the performance criteria are met.
Who Should Choose Equity Compensation?
Equity compensation is appropriate for a wide range of individuals and companies, especially those who want to exchange a degree of guaranteed cash pay for high-growth returns.
-
Employees
Equity compensation is suitable for employees who have a long-term perspective to stay in a company and are risk-tolerant.
-
Executives
For executives, equity compensation is suitable since it aligns incentives, provides high growth potential, and attracts top talent.
-
Startups
Startups can also use equity compensation since they lack enough cash flow, have high potential for returns, and have a long-term commitment.
Example of Equity Compensation
To understand the full concept of equity compensation more deeply, have a look at this example. Let us consider a digital marketing startup, ABC, which wants to attract and retain talent. ABC can use equity compensation in the following ways:
-
Stock Options
ABC offers stock options to its employees to buy shares at INR 40 each, vesting for 3 years. If the company’s stock price increases to INR 100, employees can exercise the options, buy them at INR 40, and sell them for a profit of INR 60.
-
RSUs
ABC allows RSUs equivalent to 15% of an employee’s annual salary, vesting over 4 years. When the RSUs vest, the employee gets shares worth INR 50 each.
Final Thoughts
Equity compensation helps an organisation to align shareholders with the interests of employees. By offering RSUs, stock options, and other equity-based incentives, companies manage to attract and retain employees while driving long-term growth.
Are you interested in equity trading? Download the PL Capital Group – Prabhudas Lilladher application and open a Demat account for free. PL allows you to invest in stocks, mutual funds, and a lot of unique investment options.
Frequently Asked Questions
1. What is equity compensation, and how does it function?
Equity compensation provides employees ownership in their organisation, such as stock options, RSUs, ESPPs, or performance shares, instead of just paying cash. It aligns the financial interests of employees with the company’s success to attract and retain talent. It also works as a reward for employees.
2. What are the different types of equity compensation?
The different types of equity compensation plans are stock options, NSOs and ISOs, RSUs, performance shares, and ESPPs.
3. What is the difference between RSUs and stock options?
The difference between RSUs and stock options is that stock options offer employees the right to purchase company stock at a fixed price, while RSUs help companies pay shares according to a vesting schedule.
4. What are the tax implications of equity compensation?
The tax implications of equity compensation vary depending on its type. On RSUs vesting and share delivery, employees consider income and incur tax liability, as per the present fair market value of shares.
In stock options, employees do not incur taxes on the granting of the stock option and may owe taxes after exercising the options and purchasing or selling the shares. However, in performance shares, taxes are incurred on vesting once the performance criteria are met.
5. Who is eligible for equity-based compensation?
The eligibility criteria for equity-based compensation include key employees, executives, and high-performing individuals. However, they can extend to advisors or consultants for some plans.
6. Is equity compensation better than a cash salary?
Neither equity nor cash is ‘better’ since cash offers immediate liquidity, while equity compensation provides high growth opportunities with significant risk. Always prioritise your financial situation and risk tolerance before choosing between them.
7. How do companies benefit from offering equity compensation?
Equity compensation provides benefits for a company in numerous ways. It helps startups that do not have enough capital to pay salaries, attract and retain top talent, and enjoy tax deductions.
