There are a variety of ways that companies can attract and keep employees. Whether through leave options and other paid time-off perks, extensive health care coverage, or the ability to work remotely, companies have no shortage of benefits to offer to stand out from the crowd when attracting talent.

For highly compensated employees or employees of startups, you may also be offered compensatory benefits like equity compensation.

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What Is Equity Compensation?

Equity compensation is non-cash compensation in the form of equity in your employer’s company. The two biggest reasons your company might offer you equity compensation include the following:

1. Tying your job performance to the value of the company means that the better you perform your job duties, the better the company performs. Thus the better your shares of company stock perform.
2. Disincentivizing you from leaving the company—For this reason, equity compensation can be considered a form of "golden handcuffs" because submitting your resignation will cause you to lose out on some of these stock benefits

But what happens to equity compensation if you get laid off? Companies are looking to conserve their bottom line in our current economic environment, and even huge companies like Microsoft aren’t immune to large-scale layoffs.

If you work for a smaller employer, you may be able to negotiate the terms of your compensation, but if you work for a large company, there's more likely less flexibility behind the agreement. And if you work for a private company, your ability to offload vested equity to either cash in gains or address liquidity needs may be limited. Ultimately, it could all depend on the type of equity compensation you have. So, let's look at some forms of equity compensation and how they may be affected by a layoff.

Types of Equity Compensation

There are many kinds of equity compensation, but the most common are restricted stock units, incentive stock options (ISOs), non-qualified stock options (NSOs), and employee stock purchase plans (ESPPs).

Restricted Stock Units (RSUs)

RSUs are shares of company stock given to an employee over a vesting schedule. This means that after a certain period (or sometimes when employee performance goals are met), some or all of the shares become available to the employee at fair market value. Vesting also triggers compensation based on the value of the shares. At that point, the employee can keep them and hope the stock increases in value or sell them immediately and pocket the proceeds. For this reason, RSUs are arguably the most straightforward form of equity compensation because once the shares have vested, you own them outright; no purchasing process needs to take place.

If you're laid off and have RSUs, your options are similarly straightforward. If your RSUs have not yet vested, you lose them (or if a percentage has not yet vested, then you lose that percentage). You retain all vested RSUs; from there, you're free to sell right away or hold onto them and see what happens.

Incentive Stock Options (ISOs) & Non-Qualified Stock Options (NSOs)

If your company grants you stock options (either ISOs or NSOs), it simply means they are allowing you to buy shares of stock in the company at a specific price (exercise price) during a particular window of time (vesting period). To obtain shares of stock under a stock option, the employee must still purchase the stock, differentiating stock options from RSUs.

Suppose you're laid off and have either ISOs or NSOs. In that case, it's essential first to go back to your equity compensation agreement to evaluate your options (no pun intended) and the timeline you have to decide. For instance, while you typically lose out on unvested options when employment is severed for any reason, your equity compensation agreement might have exceptions for layoffs. Additionally, it's common for companies to offer a 90-day window to exercise vested options (though the precise amount of time is dependent on the company, so again, review your equity comp agreement). At this point, your options might expire, or your ISOs could even convert to NSOs. This forces you to weigh many factors and make potentially significant decisions under a ticking clock.

How your options are taxed needs to be top of mind when making these decisions because the critical benefit of ISOs is their opportunity for preferential tax treatment. If you wait to sell shares acquired at least one year after you exercised your ISOs and at least two years after they are granted, you trigger a qualifying disposition. At this point, any profits you make from the sale of your stock are taxed at the lower long-term capital gains rates. This is in stark contrast to NSO taxation, which taxes the spread between the option strike price and fair market value of the shares as ordinary income. All subsequent growth, if held, will be subject to long-term or short-term capital gain, depending on your subsequent holding period. Additionally, although no ordinary income is recognized when you exercise an ISO, you need to be aware of potential alternative minimum tax (AMT) implications.

Figure 1. Rates at Which Your Stock Options May Be Taxed*

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*Long-term capital gains and regular income tax rates depend on your income and tax filing status.

When faced with these decisions, you have three potential strategies: exercise and sell, exercise and hold, or wait to exercise and sell.

• Exercise & Sell: If you’re strapped for cash or need an immediate source of income, it might make sense to exercise your options and immediately sell the shares. However, be cautious of the tax consequences, as your short-term capital gain is taxed at the same rate as your regular income. Additionally, make sure to plan to fund your shares' actual purchase.
• Exercise & Hold: If you have a relatively short window to exercise, or if you're in a "use it or lose it" situation, you may decide to exercise your shares and hold onto them to let them grow. On the one hand, this strategy forces you to put faith in the growth of a company that just laid you off, but on the other hand, it may be your best opportunity to get the most out of your options. Additionally, if you decide to utilize this strategy, you should prioritize options that are the most "in the money.” Keep in mind that holding a position in one individual company carries more risk than that of a diversified portfolio and should have a commensurate expected return as a result. It might make sense to limit how much of your net worth you want your individual stock position to represent.
• Wait to Exercise & Sell: This strategy could end up being the most beneficial if the terms of your equity compensation agreement are unchanged by your layoff and you don’t need an immediate source of income. In general, you should hold options with a long period to expiration to take advantage of the inherent leverage.

Additionally, you still get to keep shares that have already been exercised before or after your layoff. And, of course, the above strategies are simply suggestions—not universal rules or solutions. With your financial advisor and your unique situation in mind, final decisions on what to do with your ISOs or NSOs should be made.

Employee Stock Purchase Plan (ESPP)

ESPPs function a little differently than options. For one, money is taken directly from your paycheck and contributed to an account that purchases stock on your behalf—much like a 401(k). There’s also no vesting period before you can purchase the stock, and instead of being able to exercise options at a set price, you can purchase company stock at a specified discount. For example, your ESPP might offer company stock at 15% off the fair market value (FMV). So, if the FMV of your company's stock is $20 per share, you can purchase stock at $17 per share.

If you’re participating in an ESPP and are laid off, you should, once again, immediately review the specifics of your plan. The stock you've already purchased is still yours to keep, and any money contributed to the plan but not yet used to buy the stock is refunded to you. Beyond any nuances or quirks in your plan, you have the same fundamental decisions as if you were offered options: you could immediately sell your shares if you need liquid funds or hold onto them and see what happens.

Additionally, ESPPs can receive preferential tax treatment just like ISOs, so how your shares will be taxed needs to be considered.

What Equity Compensation Strategies Are Right for Me If I’m Laid Off?

If you’re laid off, you have a lot to think about. How your layoff affects your equity compensation may be the last thing on your mind, but it’s something that you need to consider. Equity compensation decisions should never be based on one factor alone, and it can be hard not to be biased when you are a recently separated employee.

That’s why it’s best to work with an advisor who considers your entire financial life. An advisor acting as an impartial voice of reason can help you evaluate how existing equity compensation fits into your financial plan and how best to use these resources, given your new circumstances.