Stock Options Have Your Stomach in a Knot?

As California and the U.S. continue to lead the world in innovation, equity compensation offered by publicly and privately held companies remains a key tool in attracting and retaining talented, driven employees.  Equity compensation can pave the way to significant wealth for those that are offered the opportunity and participate.

While these incentives are exciting, they also come buried underneath a dizzying array of documents that usually include purchase agreements, stock award grant agreements, option agreements, detailed incentive plan overviews and a bevy of notices and forms - not to mention limited exercise windows and significant tax ramifications.

Long-time employees become well-versed over the years with each new offering and opportunity.  As seniority grows, concentrated wealth becomes an issue and you may find yourself asking the following questions:

1. Should I sell some of my stock awards and/or options?
2. Should I elect to receive additional stock awards or am I better off with stock options?
3. Is it smart to have so much of my net worth concentrated in the company I also depend on for my paycheck?
4. If I divest, how do I reallocate and invest the proceeds?
5. Should I only liquidate enough to buy or renovate my home?
6. What are the tax ramifications of the choices I make?
7. Am I thinking about all of this correctly?
8. How does all of this fit into my larger life plan?

Obviously, these are complicated, personal questions. There is not an easy answer to any of them. The key is to understand how your financial life fits together now and how you want it to fit together in the future.

Due to the complexities built into equity compensation, employees are often lured into a state of avoidance and inaction.  While this can work out fine early in one's career, the stakes get larger as time passes. Equity concentration can be a great way to build wealth, but is rarely a good strategy for maintaining wealth.  Diversification certainly has it merits, as demonstrated by 2020 and the COVID-19 pandemic. 

If you need assistance or just want to double check your thought process, feel free to reach out to us for additional perspective. 

If you are new to the world of equity compensation, below are the basic terms you should become familiar with:

Vesting Schedule

Equity compensation typically comes with a vesting schedule.  Types of vesting schedules include immediate vesting, graded vesting and cliff vesting.  Employees assume full ownership of assets once they are fully vested. If an employee leaves a company prior to assets becoming fully vested, the assets may be forfeited.  

Stock Options

With stock options, employees have the opportunity to purchase stock at a predetermined price over a specified period to time.  Once stock options are fully vested, employees may choose to exercise them.  It’s important to note that employees that own stock options are not stockholders and do not have the same rights as shareholders.  

The two types of stocks options are: non-qualified stock options (NSOs) and incentive stock options (ISOs).  The primary difference between these two option types is their tax treatment.

1. Non-Qualified Stock Options (NSOs)

When NSOs are exercised, the difference between the exercise price and the current market value of the stock is usually taxed at ordinary income tax rates. Capital gains will also be due upon the sale of the stock.

2. Incentive Stock Options (ISOs)

Unlike NSOs, ISOs are not taxed when options are exercised.  Rather, capital gains tax is due on the sale of the stock.  To qualify for long-term capital gains treatment, the shares typically need to be held for one year following exercise and two years from the original grant date.  If these requirements aren't met, a disqualifying disposition may trigger tax ramifications.

Restricted Stock Units (RSUs)

These stock awards are restricted according to the firm's vesting schedule. Once vested, shares are received, along with the voting and dividend rights that come with them.  The market value of the shares upon receipt (typically at the vesting date) is counted as taxable income.  Capital gains will be due once the shares are sold.

Stock options, RSUs and equity compensation programs and their tax treatment are complex.  The above information is meant as a basic introduction.  Make sure to consult with your CPA regarding the specifics of your potential tax liabilities prior to taking any action.

-------------

^{Advisory services are offered through Darrell Capital Management, LLC, an Investment Advisor in the Sate of California.  All content is for informational purposes only.  It is not intended to provide any tax or legal advice or provide the basis for any financial decisions. Nor is it intended to be a projection of current or future performance or indication of future results. Investing always involves risk and the possible loss of capital. Opinions expressed herein are solely those of Darrell Capital Management, LLC.  The information contained in this material has been derived from sources believed to be reliable but is not guarantee as to accuracy and completeness and does not purport to be a complete analysis of the materials discussed. Being registered as an investment advisor does not imply a certain level of skill or training. Social media posts reactions and comments should not be viewed as endorsement or testimonials. The information contained herein should in no way be construed or interpreted as a solicitation to sell or offer to sell advisory services to any residents of any state other than the state of California or where otherwise legally permitted.}