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Deferred Equity Plans – Definition, Benefits, and Key Considerations

What are Deferred Equity Plans?

A Deferred Equity Plan is a form of compensation under which employees, or possibly other persons such as independent consultants or contractors, receive either shares or stock options at a future date instead of receiving them immediately at the grant. Such plans are administered as retention incentives aligned with the company’s interest in long-term growth. Shares or stock units are usually granted based on performance, tenure, or conditions. DEPs, meanwhile, assist companies in maintaining a competitive compensation regime without any outflow of cash immediately, thereby retaining and motivating top talent.

How Deferred Equity Plans Work

The working of Deferred Equity Plans essentially revolves around the hitherto-mentioned conditions under which employees are to receive equity grants at a later date. Those conditions are most usually linked to performance metrics, time-based vesting, or some other strategic objectives. The whole process is broken down into four key stages:

Vesting Period: The period during which employees are required to fulfil described obligations may involve continuous employment or the attainment of performance targets. Vesting could be time-based (e.g., vested over a four-year period) or dependent on performance achievements (e.g., contingent upon revenue growth).
Settlement: Employees are awarded shares or options when vesting conditions have been met, and these may be retained or sold. Shares may be subject to holding restrictions as imposed by the company.
Tax Considerations: Tax implications vary based on the plan structure and state regulations. Deferred equity is generally taxed at the time it vests or when the shares are sold. It is advisable for the employee to check with his or her tax advisors on planning for potential tax obligations.
Liquidity Events: Some plans allow for the sale of shares only in definite liquidity events, such as the initiation of an IPO or acquisition, with the limitation of immediate access to funds.

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Types of Deferred Equity Plans

Different types exist for Deferred Equity Plans based on various corporate objectives and employee incentives. Corporations may offer either one or a combination of such plans, depending on their compensation strategy.

Restricted Stock Unit (RSUS): In this provision, employees are entitled to get shares after fulfilling some vested conditions, usually time-featured or performance-based. The RSU is one of the most common forms of delayed equity.
Stock Options: This right entitles employees to purchase shares at a predetermined price after a certain date. Incentive Stock Options and Non-Qualified Stock Options (NSOS) fall into this section.
Performance Shares: Equity is granted only in the event that certain financial or operational hurdles are achieved, such as revenue milestones or profitability targets.
Stock Appreciation Rights (SARs): This grants employees a benefit equals to any increase in stock value for a specified time without granting stock ownership itself.

Benefits of Deferred Equity Plans

Deferred Equity Plans have several key benefits for both the employee and the employer, making them a widely used long-term incentive scheme. They play a role in the company’s attraction, motivation, and retention of talent.

Employee Retention: This retains employees longer by tying compensation to the duration of their stay at the company.
Corporate Goal Alignment: Employees are motivated to raise company performance as their equity value depends on it. It creates a sense of ownership and accountability.
Tax Benefits: In certain jurisdictions, taxes can be deferred until the shares are vested or sold, thus benefiting employees by allowing them to plan their tax obligations wisely.
Customizable: Vesting schedules, performance conditions, and distributions can be tailored according to business requirements.
Market Competitiveness: Companies go the extra mile to offer equity-based compensation to attract talent from the front lines, especially in high-growth industries.

Risks and Considerations in Deferred Equity Plans

Although beneficial, the Deferred Equity Plans also pose certain risks and challenges to both employees and employers. It is worthwhile to understand the risks before these plans can be implemented or participated in.

Stock market volatility: Employees might receive considerably less value than expected should stock prices fall, which adds an element of unpredictability to their deferred compensation.
Complicated tax treatment: There are different tax treatments for different jurisdictions, thus requiring ample planning. Employees may be suddenly burdened with unexpected tax implications if they haven’t planned accordingly.
Administrative obligation: The management of equity plans for compliance, record-keeping, and employee communication, by default, requires a dedicated resource.
Regulatory compliance: The legal and accounting requirements concern transparency and fairness in the distribution of equity among qualifying employees.
Psychological effect: Employees heavily dependent on equity compensation may suffer financial anguish due to poor stock performance, which would adversely affect morale and job satisfaction.