A Guide to Equity Compensation for HealthTech Employees

Healthtech is rapidly evolving, with innovations in medical devices, digital health, and biotechnology revolutionizing healthcare for the better. 

For workers in this dynamic field, understanding equity compensation is crucial. Why? Because it allows you to understand your benefit entitlement and maximize your financial rewards.

In this article, you will learn about equity compensation in healthtech—including stock options, RSUs, and ESPPs—and understand vesting, tax implications, and how to optimize employee benefits.

What Is Equity Compensation, Exactly?

Equity compensation is a form of non-cash pay where employees receive ownership stakes in a company, typically through stock options, restricted stock units (RSUs) or other equity-based incentives.

It is commonly used by startups and growth-stage companies to attract and retain talent while aligning employee incentives with company performance.

Common types of equity compensation include:

• Stock options
• Restricted stock units (RSUs)
• Employee stock purchase plans (ESPPs)
• Incentive stock options (ISOs)
• Non-qualified stock options (NSOs)

Equity Compensation vs. Cash Compensation

Equity compensation works by giving employees ownership potential tied to company performance. It is inherently riskier than cash compensation, so employees must believe in the company’s long-term growth and be willing to trade some guaranteed income for the possibility of future financial rewards.

Cash compensation provides immediate, guaranteed income through traditional means like salaries and bonuses. Companies offering cash compensation must offer competitive salaries in order to attract qualified talent.

There’s no one right way to compensate your employees, but many healthtech companies use a mix of both to balance risk, retention and financial constraints.

Combining competitive salaries with an equity package can help your healthtech company attract top talent, while also encouraging your employees to stay invested in the success of your company.

Why Is Equity Compensation Common in HealthTech Specifically?

Healthtech is a highly competitive industry that demands top talent to fuel innovation. With a limited pool of skilled workers, attracting and retaining the best becomes a top priority. 

By linking compensation to the success of the organization, it motivates employees to perform at their best, driving both individual and organizational growth.

Is Equity Compensation Right for Your Business?

Equity compensation may be appropriate for companies that are growing quickly, hiring key talent, conserving cash or seeking long-term employee alignment. Companies with stable cash flow and limited growth plans may have different compensation priorities.

Understanding the Different Types of Equity Compensation

There are four key types of equity compensation:

• Incentive Stock Options (ISOs): ISOs are offered to employees and provide tax benefits. If held for a specific period, gains are taxed at the lower capital gains rate rather than as ordinary income.
• Non-Qualified Stock Options (NSOs): NSOs are available to employees, directors, contractors, and others. They do not qualify for special tax treatments and are taxed as ordinary income upon exercise.
• Restricted Stock Units (RSUs): These represent a promise to deliver shares to employees once certain conditions are met, typically vesting over time. Unlike stock options, RSUs have value at vesting without needing to purchase shares. They are taxed as ordinary income when they vest, based on the fair market value of the shares.
• Employee Stock Purchase Plans (ESPPs): ESPPs allow employees to purchase company stock at a discount, typically through payroll deductions over an offering period. If the stock price rises, this can lead to gains. Qualified ESPPs offer favorable tax treatment, including potential capital gains tax rates on profits if shares are held for a specified period.

How to Choose an Equity Compensation Structure

Which equity compensation structure is right for your company? The answer depends on your current growth stage and how much extra cash you have in your budget.

• Early-stage startup: Stock options are often the most flexible choice. They can offer employees significant value if the company grows.
• Growth-stage company: RSUs may be a more attractive option, as they provide employees with shares once vesting requirements are met. They offer greater predictability for both employers and employees.
• Cash-constrained teams: Equity-heavy compensation packages can help startups attract talent who believe in your company’s long-term potential. High equity can offset lower salaries and keep you competitive with larger public companies.
• Highly regulated environments: All equity plans should prioritize clarity and compliance to meet legal and tax reporting requirements. No matter what structure you choose, clear documentation helps employees understand the value of their equity award.

Understanding Vesting

The terminology used for equity compensation can be confusing, so here are some definitions to help you understand vesting:

“Vesting” is the process by which employees earn the right to own shares or stock options over time, giving them gradual ownership and access to benefits.

A vesting schedule dictates when employees can receive their equity compensation. The total length of time it takes for an employee to receive all their shares and options is known as a vesting period.

• Cliff Vesting is a schedule that ensures an employee receives 100% of the shares or options after a specified period (e.g., one year).
• On the other hand, Graded Vesting is where the employee earns a portion of the shares or options gradually over time. For example, 25% per year over four years.

Once the options are vested, the employee has the right to “exercise” them, meaning they can purchase the company’s shares at a predetermined price (known as the exercise or strike price).

Why Vesting Is Important for Healthtech Organizations

Vesting schedules ensure employees stay with the company to earn their full compensation, helping retain talent and preventing them from leaving for competitors. They also serve as a performance incentive, motivating employees to drive business success as the value of shares or options increases over time.

Tax Implications of Equity Compensation

It’s important to consider how each type of equity compensation is taxed because it can have a significant impact on the value of each option. Additionally, different taxation can apply at various stages of the process, including when the options are sold.

For all options, there is no tax at the grant stage.

Here’s a quick overview of when tax applies:

What Are the Risks of Equity Compensation?

Although equity compensation can offer significant financial rewards if the company performs well, it also carries risks. Bear these in mind before offering them to your workforce:

• Equity value is success-dependent: The value of equity hinges on the organization’s success, so your healthtech company must be able to demonstrate positive forward momentum to potential employees before offering equity compensation.
• Market volatility: Fluctuating stock prices can severely affect the value of the equity. Even strong companies experience periods of declining stock value, which may reduce the perceived value of compensation.
• Ownership dilution: Equity compensation can dilute ownership and create complexity in valuation and compliance. As your company grows, you’ll need to plan carefully to manage ownership percentages.
• Misaligned expectations: Poorly structured plans can lead to confusion, disappointment or even employee retention issues. Employees should clearly understand how vesting and potential payouts work prior to joining your team.

To mitigate these risks and keep equity compensation appealing, you should offer it alongside competitive salaries, healthcare, bonuses and other attractive benefits.

Finvisor for Effective Equity Compensation Management

While equity compensation is a powerful tool in the healthtech industry, it’s not easy to implement or navigate without financial expertise on hand.

If you want to unlock your workers’ potential by offering this benefit, Finvisor can help you. Our team of financial professionals has significant experience in healthtech and understands how to successfully implement equity compensation plans that align with growth, compliance and talent retention.

To find out more, get in touch with a team member today!