Understanding Performance Shares: Your Guide

As companies seek to build ambitious, effective compensation strategies, boards are considering ways to incentivise people with equity that can foster a sense of ownership while remaining tethered to commercial and strategic targets. 

Performance shares are widely used by companies in this position. Here, we’ll cover how performance shares can benefit different kinds of company, and how they compare with other forms of employee incentive such as restricted stock units (RSUs).

What are performance shares?

Also known as performance stock units (PSUs), performance shares are a type of equity compensation that grants equity to employees if particular business targets are achieved. 

The specific conditions that define the vesting triggers for performance shares are customarily laid out in the company’s equity plan documentation, and usually in employee equity agreements too.

Performance shares vs. RSUs

For late-stage private companies and public companies, performance shares and RSUs perform similar roles. But there are some important differences to bear in mind when considering whether performance shares or RSUs might be right for your business.

Here's a simple table comparing some of the stand-out features of performance share plans and RSUs:

Acceleration

Performance shares and RSUs aso differ in how they deal with vesting acceleration events. (Acceleration takes place when certain events trigger earlier-than-standard vesting. These events will be pre-defined in the employee equity agreement and in company-level documentation. For instance, many companies’ stock options include single or double trigger acceleration in the event of a stock market listing or acquisition.)

Some companies establish that the RSUs they grant may accelerate if certain performance-related triggers are met. (If you’re thinking that this makes performance-related RSUs very similar to performance shares, you’re right!)

How do performance shares work financially for companies?

Performance shares are designed to deliver for employers and employees alike. For employers, rewards for the team are contingent on hitting business goals, meaning that employees earn equity stakes only if the business performs to a satisfactory level. For employees, performance shares carry a number of benefits, including the structure of tax payments. Like RSUs, performance shares are only taxable once they are vested and granted to the employee, with no upfront pre-vesting taxation to contend with.

Accounting treatment

Normally, performance shares have a predetermined performance period – the timeframe during which performance is measured, in order to dictate the amount of shares to be granted. For accounting purposes, the fair value of performance shares at the date of grant can be amortised over this performance period. For stock-settled performance shares, compensation costs are not reversed after the end of the performance period is reached, whether or not the conditions to vest the shares have been met. Costs for cash-settled performance shares, on the other hand, can be reversed depending on whether the goals that dictate vesting have been achieved.

Adjusting in-progress performance shares

Performance shares depend on hitting business objectives – but business objectives can change over time. For instance, if the company undergoes a strategic pivot, the metrics that are most important to a business might change. Or, force majeure conditions in a market may render established targets unachievable. Each of these circumstances may affect how many performance shares are earned by team members, therefore impacting cap table management.

In these cases, it is possible for the board to decide to either change the metrics used to set performance-related goals, or to increase/reduce the level of attainment required for performance shares to vest. An example of a metric change might be shifting from revenue-related goals to profitability, if profitability becomes materially more important to the company’s success versus revenue growth.

Key features of performance share plans

Performance shares can be a crucial way to incentivise people while tethering equity to business goals. So what are the most important aspects of performance share plans for companies to bear in mind?

• Flexibility: Companies are free to set their own performance conditions that will trigger vesting of employees’ shares. Common metrics that are treated as conditions for performance share vesting are revenue, earnings and/or earnings per share, and/or year-on-year growth rates.
  
  
• Vesting and grants: Performance shares may be subject to annual grants with varying performance conditions: for certain employees, this might mean that different tranches of equity are running concurrently.
  
  
• Connection to organisational goals: more so than any other form of equity compensation, performance shares are inherently tied to business performance and overall strategy. This also means that if company goals or market conditions change, though, the metrics that define whether or not performance shares have been earned may also need to change.

FAQs

Do performance shares expire?

Almost always, yes: most performance shares have an expiry date by which time the pre-defined business milestone should have been reached. Whether it’s 12 months or 10 years, there will normally be an expiration to these grants.

What is the difference between performance shares and stock options?

While stock options represent the option to buy a stake in a company at a given point in the future, performance shares are shares. Once vested, the owner of performance shares automatically becomes a shareholder in the company. Vested share options still need to be exercised in order to become shares.