So you have a job offer that includes: a salary, check; health insurance, check; vacation pay, check; sick days, check; stock options, che… wait a minute. Back up. What exactly are stock options?
In order to attract and keep valuable employees, companies often give new executive hires the opportunity to purchase a certain number of shares at a specific price. Some businesses offer options to all their workers.
A company hopes options will make its employees feel invested because they own a piece of the pie — they’ll work harder and stick around longer. This can be a great deal for both sides.
Google extended stock options as a start-up, and its in-house masseuse became a millionaire. She was far from the only employee to benefit.
Before you jump at the chance, make sure you know what you’re doing. Brace yourself: Some technical terms are involved. Stock options can be a great employment benefit, but you must be aware of the rules and procedures governing them.
Short and Sweet
Here are the stock option basics: Your company gives you the chance to buy X amount of stock at Y dollars each for Z amount of time. This offer is the “grant.” Clearly, there are variables at play here.
Your company will cap how many shares you can buy or “vest.” They’ll tell you when you can start buying — the “grant date” — and when the opportunity is over.
Time and Date
You may be given a length of time — “the vesting schedule” — when you’re allowed to buy specific percentages of the total offer during shorter periods.
For instance, if you’re offered 300 shares over three years, the vesting schedule could limit you to purchasing no more than 100 shares each year. Examples aside, the standard purchase term for stock options is 10 years.
A stock option agreement also identifies a waiting period before you can sell your shares.
Up and Down
The company names the “exercise price,” which is the cost of each share. This may be higher, lower or equal to the market value price and has nothing to do with CrossFit or Zumba.
The exercise price generally stays the same throughout the term of the option. However, if a company’s stock drops significantly, it might lower the exercise price, hoping employees will keep snapping up shares.
Give… and Give Some More
Of course, the Internal Revenue Service gets involved. How far they dig in depends upon the type of stock option.
“Incentive stock options,” or ISO, are for executives. “Non-qualified stock options” — NSO — are for the masses: non-executives, outside directors and consultants.
ISO aren’t taxed until they’re sold. If an executive buys stock and then turns around and sells it, the proceeds are treated as standard income.
However, if the investor holds out for two years after the grant, profits are treated like long-term capital gain. This means that the taxes may be lower.
Taxation of NSO begins as soon as you buy stock. The difference between what you paid and the market value is considered compensation. It’s taxed just like your salary. When it comes to selling NSO, however, gains are treated the same way as ISO revenues.
Ins and Outs
So how do you decide whether to invest in stock options? How much do you buy? When do you sell? There are several issues to consider:
- Non-competitive clause: Even if you don’t have this provision in your contract, it may be in the stock option agreement. How likely are you to leave the company and work for a rival? If you do, you’ll lose your stock.
- Cost: Can you afford the purchase price for the stock? If it’s NSO, how will it impact your current taxes?
- Company Health: How confident are you about your company’s overall condition? Is the business profitable? Are things running smoothly? If not, selling your shares could be a challenge.
- Startup Concerns: Startups give you more to think about. How long until there’s an initial public offering? If it’s not on the horizon, will it ever occur?
If there’s no IPO and the startup is sold, the original investors get first dibs on getting their money back, with interest. Employees recoup their investments if there’s anything left over.
In startups, shares can change with new funding sources. The number or value of your shares could potentially plummet.
Choices and Decisions
Now that you know what’s going on, it’s up to you to decide how much stock options are worth to you. If they come with a job offer, is the rest of the compensation package smaller? Or are they a nice bonus?
If your current company is offering you the chance to pick up some stock, can you afford the investment right now? It’ll be a while before you can cash your options in.
What happens if the stocks drops and keep dropping?
Playing the stock market, even with your company’s support, is a bit of a gamble. How lucky — or smart — do you feel?