Equity Compensation: A Tool for Talent Attraction and Engagement

How do you hire great employees in a dry talent pool and competitive hiring market? Add limited budget and it starts to feel like Mission Impossible. While we can’t send Tom Cruise to the rescue, there is a secret weapon you can use: equity compensation.

By offering future ownership in your company, not just a paycheck, you can attract ambitious, growth-minded employees who are invested in your organization’s success.

This guide breaks down how equity compensation works, why it’s so effective for hiring and retention, and how to implement it in a way that works for your business.

TL;DR — Key Takeaways

• Equity compensation is a non-cash payment method that companies use to give employees a share of the business.
• Immediate ownership and earned equity over time are the two main methodologies, but most businesses choose the second option.
• There are four main types of equity compensation: stock options, restricted stock units, employee stock purchase plans, and performance shares.
• Equity compensation typically makes sense for startups with limited cash, fast-growing companies, or businesses preparing for an IPO or acquisition, especially in competitive markets where cash bonuses aren’t feasible.

What is equity compensation?

Equity compensation is a non-cash payment method companies use to give employees an ownership stake in the business. The most common forms of equity compensation are:

• Stock options
• Restricted stock units (RSUs)
• Employee stock purchase plans
• Performance shares

Equity compensation is most often used in startups and high-growth companies. Instead of splurging on large salaries (often because they can’t), these businesses offer equity to attract great talent while holding on to precious cash flow.

How equity compensation works

Let’s say your startup offers new employees 10,000 stock options at a strike price of $5 per share. These options vest over four years, so they have the right to purchase all 10,000 shares at $5 each after this amount of time.

Scenario 1: The startup grows, and the company goes public

The startup revenue grows, attracts investors, and eventually launches an IPO at $50 per share. The employee chooses to exercise their options:

• The cost: 10,000 shares × $5 = $50,000
• Market value: 10,000 shares × $50 = $500,000
• Profit: ⚡ $450,000 before taxes

Scenario 2: The company is acquired

Instead, the company is acquired, and the valuation is now $100 per share.

• The cost: 10,000 shares × $5 = $50,000
• Acquisition payout: 10,000 shares × $100 = $1,000,000
• Profit: ⚡ $950,000 before taxes

How do you pay equity compensation to employees?

Equity compensation is typically granted over a period of time to encourage long-term commitment in employees. Here are some common structures:

• Time-based vesting: The most common approach, where equity vests incrementally over several years (e.g., four-year vesting with a one-year cliff). This means no shares are earned in the first year, but after that, a percentage vests regularly (e.g., 25% after one year, then monthly or quarterly thereafter).
• Performance-based vesting: Shares vest only if employees meet specific performance goals, such as revenue milestones or product launches.
• Hybrid vesting requirements: A combination of time-based and performance-based criteria.

Alongside these structures, employees must also meet specific conditions to own their equity in full:

• Staying with the company: Employees forfeit their shares if they leave before completing the vesting period.
• Liquidity events: Some equity (especially RSUs in private companies) only becomes valuable after an IPO or acquisition.
• Exercise requirements: Stock options require employees to buy shares at the grant price to own them outright.

Immediate ownership vs. earned equity over time

Equity compensation can be structured in two ways: immediate ownership or earned equity over time. The key difference is whether employees receive full rights to their shares upfront or must stay with the company for a set time period to gain ownership.

Immediate ownership: rare and high-risk for companies

Companies sometimes grant equity immediately, meaning employees own their shares from day one. This is far from common because:

• Employees could leave just after receiving shares, eradicating any retention benefits from this incentive.
• Employees don’t have any built-in incentive to contribute to the company long-term.
• It increases dilution risk without ensuring company growth.

Earned equity over time: the standard approach

Most companies require employees to earn their equity gradually through a vesting schedule so they contribute to the company’s success before fully owning their shares.

In many cases, this is the more common and sensible option, although James Pilkington, Head of Compensation Data Solutions at Aon, notes some pitfalls:

• Some employees coast until their vesting date, contributing the bare minimum before moving on.
• High performers leave early, even forfeiting unvested equity if better opportunities arise or future employers offer buyouts.
• In down markets, when stock prices decline or stagnate, equity loses its perceived value and retention impact.

Types of equity compensation

There are various types of equity compensation plans, so pick one that aligns with your company’s goals and the value you want to provide to your employees.

Stock options

Stock options let employees buy company shares at a fixed price (strike price), regardless of future market value. If the stock price rises, employees can purchase shares at a discount and sell them for a profit.

How stock options work

• Grant: The company offers stock options with a strike price (e.g., $5 per share)
• Vesting: Employees must stay for a set period before they can exercise options
• Exercise: Once vested, employees can buy shares at the strike price
• Sell: If the stock price rises (e.g., $50 per share), employees can sell for a profit

Why companies offer stock options

• Promote long-term retention by tying rewards to tenure
• Appeal to employees who are optimistic about company growth
• Offer high potential upside without upfront cash cost to the company

Restricted stock units (RSUs)

Restricted stock units (RSUs) are a lower-risk form of equity compensation because employees don’t need to buy shares. Instead, they receive them for free once they vest. Unlike stock options, the absence of an upfront investment makes RSUs valuable even if the stock price drops.

How RSUs work

• Grant: The company awards RSUs but holds them until they vest
• Vesting Employees must stay for a set period. Some RSUs vest based on performance milestones like revenue goals.
• Ownership: Once vested, RSUs convert into shares (or cash equivalent)

Why companies offer RSUs

• Encourage long-term commitment and loyalty
• Provide value even if the stock plan drops (no purchase required)
• Popular with executives and senior hires due to lower risk

Employee stock purchase plans (ESPPs)

Employee stock purchase plans (ESPPs) let employees buy company shares at a discount (typically 5-15%) using payroll deductions. This offers a low-barrier way for workers to invest in the company’s future.

How ESPPs work

• Enrollment: Employees sign up during an offering period to participate in the plan
• Contribution: A portion of each paycheck is set aside during the purchase period
• Purchase: At the end of the period, accumulated funds are used to buy company shares at a discount
• Sell: Employees can sell the shares immediately or hold them (often encouraged for income tax benefits)

Why companies offer ESPPs

• Foster a sense of ownership across the organization
• Boost employee morale and engagement
• Offer flexible participation and potential tax advantages (for Section 423-qualified plans)

Performance shares

Performance shares are equity awards tied to achieving specific business goals, such as revenue milestones, market share growth, or stock price performance. Companies often use them to incentivize executives or senior leaders.

How performance shares work

• Grant: The company offers a set number of shares to employees
• Vesting: Shares vest only if pre-defined performance targets are met (e.g., reaching $10M in revenue or a certain share price)
• Payout: Once goals are hit, shares convert into actual stock or cash value

Why companies offer performance shares

• Align executive performance with company success
• Provide clear incentives for achieving strategic goals
• Useful for retention during high-stakes growth periods (e.g., pre-IPO or merger and acquisition)

When does it make sense to offer employee equity compensation?

Any company can offer equity awards, but they’re particularly handy in the following scenarios.

If you’re short on cash but high on vision

Startups (especially bootstrapped ones) struggle with cash flow and can’t match the salaries offered by industry moguls. Offering equity as compensation lets these companies compete for top performers without a significant cash reserve. Potential employees are often willing to accept a lower salary for a larger equity compensation package.

If you’re prioritizing high-impact roles

Companies experiencing explosive growth don’t want to lose their most valuable team members. Equity keeps your specialists and high performers engaged so they stay and see the fruits of their labor.

Instead of jumping ship at the next great opportunity (or waiting for a pay equity audit,) they are willing to stay until the end of the vesting period to cash out.

If you’re preparing for an IPO or acquisition

If you’re planning a liquidity event, such as an acquisition or IPO, equity can help you retain your employees before the big event, when they can see their incentive stock options turn into cash payouts.

If you’re weighing alternatives to cash bonuses

Giving out cash bonuses is common when you want to create an attractive compensation package. But it’s not always sustainable. If you’re trying to conserve operating capital, equity is a nice alternative to a bonus.

How to use equity compensation to attract great talent

Offering equity as compensation makes you more attractive to job candidates, especially in competitive industries. If you run a small business, equity can be the bait that lures in the best of the best by saying, “We’re building something big, and you’re invited.”

Here’s how to make that message count during your hiring process.

Lead with equity in your job marketing

Equity should never be a footnote. Highlight it in your job descriptions, talk about it early on in your interview stages, and explain it clearly on your careers page. Candidates won’t know it’s available unless you first tell them, and then show them why it matters.

Create a simple equity calculator

Equity can feel a bit abstract, especially for candidates who haven’t had it before. Placing an equity calculator on your job pages shows how much their shares could be worth. It turns “maybe someday” into “oh wow, that’s exciting.”

Emphasize impact and ownership

Equity makes a clear connection between effort and outcomes. Drive this point home by making bold statements like: “Your work will shape the company and your future earnings.” This promise resonates particularly well with engineers, product teams, and entrepreneurial hires who want to see how their individual impact could play out.

Share real-life stories

Personal experience is a great trust builder. If you or someone on your team chose to work here because of equity, share that message with potential candidates.

In my case, I was recently on the hunt for a full-time job and interviewed with multiple companies. When I received two offers from startups with similar salaries and benefits, I opted for the one with an equity package and a four-year vesting period. The company I turned down only offered a salary.

It was a guarantee that I would stay with them in the long run, and, provided I do great work, everyone in the company wins. And I’m happy to share this story with prospective applicants, too.

Equity compensation can boost employee engagement, too

Equity compensation helps employees perceive your company as more than just a job. It’s a long-term investment in their own future, too. With equity as an incentive, you can see some of the following:

• Increased employee productivity
• Long-term goal focus
• Lower employee turnover
• Improved collaboration
• Higher accountability between the employer and employee, and vice versa

If you’re struggling with finding ways to motivate your employees, this can be a superb long-term productivity boost.

5 best practices for offering equity to your employees

To create an equity compensation plan for your business, you need to balance employee incentives, financial sustainability, and long-term growth.

1. Provide clear, transparent documentation

Employees should fully understand what is included in their equity package. Create an equity guidebook that includes information about:

• Vesting schedules: Outline when and how equity vests
• Stock type details: Explain whether the grant includes stock options, RSUs, or ESPP participation and how each works
• Tax implications: Clarify tax consequences and liabilities (e.g., ISO vs. NSO (non-qualified stock options) taxation, RSU taxation upon vesting)
• Liquidity expectations: Indicate whether employees can sell shares immediately or must wait for an IPO or acquisition
• Exit scenarios: Define what happens to unvested or vested equity if an employee leaves the company
• General financial planning advice: Include information on how long-term capital gains work

✅ How to do this: Don’t be tempted to use AI as a generative content shortcut. Speaking on the JP Workplace Solutions podcast, Executive AI Research Director at JP Morgan Chase & Co, Charese Smiley explains, “When we interact with a large language model….we become subject to how they maintain their data.”

2. Balance short-term perks with long-term equity benefits

Equity alone may not appeal to all candidates, especially those attracted to immediate compensation. A balanced offer can attract diverse talent:

• For risk-tolerant employees (e.g., early-stage startup hires): Offer lower ordinary income but higher equity with strong upside potential.
• For experienced professionals (e.g., senior hires): Combine a competitive salary with RSUs or performance-based shares.
• For broader employee participation: Include an ESPP (employee stock purchase plan) to let employees buy shares at a discount.

✅ How to do this: Offer flexible compensation packages, allowing employees to choose between higher salary vs. higher equity based on their preferences.

3. Set realistic and strategic equity pools

Your equity pool should cover your long-term hiring roadmap without over-diluting the cap table.

✅ How to do this: Most startups reserve 10-20% of shares for employees and adjust that pool as they grow. Keep your cap table up to date and build in room for refresh grants.

4. Define vesting structures that reflect modern retention

The old-school four-year cliff doesn’t work for everyone anymore. Younger employees may expect faster liquidity or leave before long-term vesting kicks in.

✅ How to do this: Test alternatives like no cliff or shorter vesting. As Robyn Shutak, Equity Compensation Expert at Infinite Equity, explains:

“Some companies have omitted the cliff on their four-year vesting. They’re essentially saying, ‘Hey, if it’s not working out for you, you can leave sooner.’ It’s that kind of philosophy where you start the company as a new hire and then all of a sudden you’re like, ‘This isn’t the right place for me, but I want to wait around a year for my award to vest after year one.’”

Ran Chen, an AI Applications Professional for Tubi, agrees that long-term vesting schedules are a problem for younger employees:

“Job hopping is common, sometimes by design, to increase pay quickly. If an average young employee expects to stay only 1–3 years at a company, a traditional four-year vesting equity grant may not fully resonate. They might discount the value of unvested stock beyond a couple of years.”

5. Educate employees on equity value from day one

Most employees don’t fully understand equity, and that’s a missed engagement opportunity. Make education a part of onboarding and reinforce it regularly with tools and training.

✅ How to do this: Use equity calculators, host Q&As, and bring in financial experts. According to Morgan Stanley, in companies where employees are highly or moderately engaged with their equity, 48% communicate about it weekly or monthly. In contrast, 70% of companies with low or no engagement only communicate annually or on an ad hoc basis.

Build a holistic talent attraction and retention strategy with Toggl Hire

Equity compensation can be incredibly powerful as a talent acquisition tool, but only when combined with other elements of a solid, integrated talent strategy.

Toggl Hire offers skills-based screening, customizable job application pages, and transparent hiring workflows so you can connect with candidates who do what they claim, are aligned with your company vision, and value long-term success rather than short-term wins.

Create a free Toggl Hire account today to find candidates who speak your language and want to stick around for the long run.