The trend of equity compensation in Singapore is constantly
evolving, and it continues to gain traction in the global startup market.
Equity compensation or stock-based compensation is a way for companies to
reward executives and employees for their contributions in the form of equity
shares. It has become the most attractive and popular way to encourage and
reward employees, whilst strengthening their loyalty and effort to their
companies. But, what is equity compensation, how to value it, and what do startup
companies in Singapore have to consider when it comes to equity compensation?
This article will cover the concept of equity compensation for startups in
Singapore.
Startups and equity compensation
To better understand what startups in Singapore need to know
about equity compensation, first, we need to understand what startups are. A
startup is a business venture that seeks to develop or start from scratch a new
business or service. In other words, a startup is an early-stage business,
which is in the process of turning a business idea or innovation, into a
sustainable business.
So, what does equity mean in this reference? Well, equity refers to the ownership of a company. Hence, equity compensation means compensating an employee with shares of the companies they are working for. As a result, from a startup's perspective, equity compensation is simply a way to reward employees for their efforts as well as to retain top performance.
What is equity compensation?
Equity compensation, also known as stock-based compensation, is a way for companies to reward the efforts of their employees. Equity compensation is usually in the form of stocks, stock options or restricted stock grants. In recent years, the adoption of equity compensation has increased especially among startups. This is because it serves as a useful tool for startups to recruit and retain talent, and thus ensure the long-term sustainability of their companies. In this way, equity compensation plays a key role in the startup ecosystem.
What are the types of equity compensation?
In Singapore, there are two main types of equity compensation that
startups can consider and these two types include stock options and restricted
stock units. Below is a description of these two types of equity compensation:
1. Stock options - Stock options are the most widely adopted
form of equity compensation in Singapore. These options allow the employees to
purchase company shares at a fixed price (also known as the strike price) and
after a certain period (referred to as the vesting period). In simple words,
stock options are an option given to employees to purchase shares at a specific
price over a set period.
2. Restricted stock units - Similar to stock options,
restricted stock units (RSUs) are essentially granted to employees to grant
them the right to own shares at a specific price over a set period. The only
difference under RSUs is that the shares issued to employees do not carry
voting right and even no dividend is paid out. As a result, RSUs are often used
to reward employees without granting them any voting power and dividend.
Importance of equity compensation
Since startups are in the initial stages and have a limited
budget to implement any kind of compensation, equity compensation is the way
they can attract and retain top talent that they need to survive. Here are a
few more reasons why equity compensation is important for startups in
Singapore.
1. Motivate talent - Equity compensation also helps to
motivate employees, provide them with a stake in the company and retain them
for years to come. This incentive allows startups to build loyalty among their
employees.
2. Corporate culture and corporate social responsibility -
Equity compensation can be a way for startups to build their corporate culture
for the long term for them to sustain their businesses.
3. Easy to implement - All the steps required for granting
equity compensation are usually simple and easy to follow, making them
achievable for startups in Singapore. Thus, making the process easy to
implement.
4. Aligns with the company's values - The sense of ownership and pride employees feel when they own equity in their companies usually helps to align the interests of employees with the companies.
How does equity compensation work?
Depending on the type of equity compensation a company
offers to its employees, the procedure of granting and issuing may be
different, but the basic principle remains the same. Generally, equity
compensation works in a restricted way, or other words, companies allow
employees to purchase shares after a predetermined period of service. For
instance, stock options are granted to employees with certain terms including
the strike price, vesting period, and expiry date.
In this case, the strike price is the price at which the
employee can purchase the shares which is based on 409A valuation, the vesting
period is the time it takes for the employee to receive their shares and the
expiry date is the date by which the employee must purchase the shares.
Overall, equity compensation is an effective way to attract, retain and reward
employees of a startup which can be easily implemented in a startup.
Pricing equity compensation
Startups are considered privately held companies, which
means the shares are not traded on a public exchange. The value of shares is
not determined by the market forces, and thus 409A valuation, in this case, is
required in private companies for equity valuation. 409A valuation is a method
of determining the fair market value (FMV) of a share in a private company. It
follows a set of standards and assumptions based on which the FMV of shares is
determined. As a result, equity compensation is priced according to the 409A
valuation. Now, you might wonder what exactly is 409A.
What is 409A?
409A valuation is considered a set of standards that are
used to determine the fair market value (FMV) of common shares or equity
valuation in a private company. It's important to note that 409A valuation was
established by the Internal Revenue Service (IRS) in the United States.
Generally, 409A valuation in Singapore is used when US holding companies with Singapore subsidiaries, Singapore holding companies with US subsidiaries, and Singapore companies with employees that are American citizens. Basically, equity compensation is determined by a 409A valuation whether it is stock options or restricted stock units.
How does 409A valuation help in pricing equity compensation?
For startups, 409A valuation can help to determine the fair market value of their company's shares and thus equity compensation can be priced according to its FMV. Usually, at the time of granting equity compensation, the strike price or exercise price of stock options or RSUs is specified by the company. In this regard, this strike price is determined according to the 409A valuation. Thus, 409A valuation plays an important role in pricing equity compensation for startups.
Things to consider while implementing equity compensation in Singapore
Now, to implement equity compensation in a startup, you need
to keep certain things in mind. The following are the main things to keep in
mind before implementing equity compensation:
1. Understand the purpose of equity compensation - Why do
you need equity compensation? how beneficial it is for the startup? what are
the goals you want to achieve with it? So, you must be clear about the purpose
of equity compensation and its importance in your business.
2. Find out the best time to implement equity compensation -
The most important aspect of equity compensation is to decide the time frame
during which the equity compensation must be implemented. This is to make the
best use of equity compensation and achieve the goals that you have set for
your business.
3. Determining the appropriate type of equity compensation -
Obtaining the right type of equity compensation for a startup is crucial. As
per the requirement of the startup such as the stage of the startup, current
situation, the need and the goals of the startup, the type of equity
compensation to be used should be decided.
4. Measure FMV using 409A valuation - After you have decided
on the type of equity compensation, the next step is to determine the price at
which the shares must be priced. In this, 409A valuation plays an important
role.
5. Be careful with the dilution - To make the best use of
equity compensation, you must be careful with the equity dilution. Typically,
equity dilution is the reduction in the percentage of ownership for current
equity holders when additional shares are issued.
6. Properly frame the terms and conditions - Be specific
about the terms and conditions of the equity compensation plan. From the
vesting schedule and strike price to the number of shares to be issued and the
taxability of the equity compensation, frame the terms and conditions for it.
7. Keep an eye on the tax implications - The tax
implications of equity compensation must be understood because avoiding tax
liabilities may result in heavy penalties or even cancellation of the equity
compensation plan.
8. Create a cap table - Keep in mind that managing,
monitoring, and tracking the shareholders is important. A cap table is a
document which helps to identify each shareholder along with the number and
percentage of shares held by them. Additionally, the details of equity
compensation are also mentioned in the cap table.
9. Regularly review and monitor the plan - The
implementation of equity compensation may have a significant impact on the
financials and performance of the business. Thus, it is important to keep a tab
on the performance of the equity compensation plan by regularly monitoring and
reviewing it.
10. Seek expert help for the best results - Why not capitalize on the opportunity with the help of experts? They can help you to monitor, manage, and track the equity compensation plan. Eqvista provides a wide range of financial services, including equity compensation, 409A valuation, and cap table management software.
Conclusion
It can be seen that equity compensation is important for a
startup in several ways. However, it is essential to remember that equity
compensation must be implemented in the right way, at the right time, and for
the right purpose. But, to ease your work, you can consult experts like Eqvista
and get their assistance. Eqvista is a perfect partner for startups because we
believe in providing comprehensive financial services that include 409A
valuation, equity compensation plan implementation, cap table management
software and much more. To know more about our services, contact Eqvista today!
