“When I started my job my company gave me equity compensation, but I don’t know what to do with it,” is a phrase I hear all of the time. Many times it’s followed by, “I really don’t understand this stuff. Please help me!” If this sounds like you then you’ve come to the right place. Our team frequently helps clients understand the types of equity-based compensation (like shares or stock options), taxes on equity compensation, how to value equity compensation, and much more.
Before making any financial decisions I think it’s important to have a basic understanding of what you’re dealing with. Our industry is full of confusing jargon. In the case of the term equity, there are actually two financial definitions.
Property Equity vs. Shareholder’s Equity
Definition #1: The amount of a property after the mortgage and charges are deducted from the value. (Property Equity)
Example: Jane’s home is valued at $500K and her mortgage balance is $425K.
$500K - $425K = $75K equity in her property
When you have equity in a property, you can consider this value as part of your net worth. It’s important to note that a real estate property is an illiquid asset, so your options to access that equity will be limited. Typically, the best ways to access the equity are through a Home Equity Line of Credit (HELOC), a reverse mortgage, or by selling the property.
Definition #2: The value of shares of ownership in a company. (Shareholder’s Equity)
Example: John received 100 shares of XYZ company valued at $50/share.
100 * $50 = $5K value of John’s equity in XYZ company.
When you own stock or equity in a company, you’ll want to consider whether the company is publicly traded or privately owned. If your equity is given to you through your employer, then this is non-cash compensation that should be valued alongside your salary.
In the case of a public company, the value of your shares will fluctuate, but you can typically liquidate your shares for cash at any point in time.
Keep in mind that If the shares were received through an employer as part of your compensation package then you’ll probably need to adhere to a vesting schedule prior to selling.
In the case of a private company, the shares won’t be liquid until there’s a liquidity event such as an IPO or sale of the company.
With private equity, the share value could fluctuate over time, but they typically won’t on a daily basis the way that publicly traded shares will.
And you might also be subject to a vesting schedule, so I typically try not to count on these assets until we know that there’s a valid option to convert these shares into cash.
So the next time you are told that you have equity, first consider the context of the conversation. Is it in reference to your home or a business? Second, consider how to value this property equity or shareholder equity and how it will affect your financial plan.
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