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What is an Equity Plan?
What is an Equity Plan?
Christian McGrew avatar
Written by Christian McGrew
Updated over a week ago

An equity incentive plan (also called a "Stock Plan", or "ESOP") is a program that companies use to award equity to their employees as a form of compensation or incentive.

The idea is to align the interests of the employees with those of the company, and to motivate employees to work towards the company's long-term success. This can be a good way for employees to build wealth and share in the company's success, while also helping to attract and retain top talent.

In practice, it is also a legal framework for the type of restrictions the employee's equity will have.

How do Equity Plans work?

The main idea behind an equity plan is that you can set aside a specific number of the company's shares to be available under the plan (typically the "plan pool").

Shares under the plan pool that haven't yet been issued as employee equity have their own percent ownership in the cap table. This allows the company to issue employee grants without diluting the founders and investors every time they do so, because the shares being issued were already previously accounted for in the unallocated plan pool.

This results in a 'cleaner' cap table, and helps avoid investor concerns about being diluted.

Some common types of equity plan grants include:

  • Incentive stock options (ISOs): These are a type of stock option that qualifies for special tax treatment under the Internal Revenue Code. For employees paying taxes in the US, this is the preferred type of stock option.

  • Non-qualified stock options (NQSOs): These are a type of stock option that does not qualify for the special tax treatment afforded to ISOs. As a result, the exercise of an NQSO is generally subject to ordinary income tax. These are more commonly issued to employees outside the US, since there is no added benefit to having ISOs in their case.

  • Restricted stock award (RSA): This is a type of equity award in which the employee is granted a certain number of shares of the company's stock, but the shares are subject to certain restrictions, such as a vesting schedule. Once the vesting has lapsed, the employee is entitled to full ownership of the shares.

  • Restricted stock units (RSUs): This is a type of equity award in which the employee is granted a certain number of units, each of which represents a right to receive one share of the company's stock at a future date. The units are typically subject to vesting and other conditions.

How do I set up Equity Plan for my company?

You will need a lawyer's assistance in order to execute the stock plan document, and generate the "form documents" from which the equity grant agreements for each employee will be generated.

Once the equity plan is set up, executing a legal amendment of the plan will be required in order to change the pool size, or any other conditions laid out in the original.

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