Not all stock option strategies are created equal, and the right strategic moves for you as a tech employee will depend on when you came on the scene.
Unfortunately, you can’t just copy your coworkers when deciding what to do with your stock options. You need a specific set of action steps for your situation.
If that stresses you out, there’s good news: you have this guide at your disposal.
To help you find the right strategy, we’ll highlight three different plans for three different types of tech employees. Simply find the one that best describes your situation and use it as your roadmap.
But first, let’s lay some groundwork that everyone with stock options should understand before making decisions or taking actions.
The Two Universal Rules to Consider When You Have Stock Options
Regardless of which stock option strategy you choose, you can use two major guidelines to help inform your decision-making.
First, you need to know the importance of when to take advantage of your options. Then, you need to know how to analyze your situation (strategically, of course) before making moves.
In a 1999 presentation at Sun Valley Idaho, Warren Buffett reminded his audience of the Greek storyteller Aesop’s wise advice about how “a bird in the hand is worth two in the bush.”
The certainty of having something in hand is worth more than the uncertainty of gaining that same thing in the future. But as Buffett pointed out, Aesop didn’t specify when this was true.
“Sometimes a bird in the hand is better than two birds in the bush,” Buffett continued, “and sometimes two in the bush are better than one in the hand.”
If a “bird in hand” is cashing out, and “two in the bush” is holding onto your options or exercising and holding onto your shares, it depends on which one of these is more valuable.
In this situation, it’s critical that you understand when cashing out is worth more than holding on to your assets. There are times — and companies — when two in the bush will be worth more than one in hand.
Consider where the company is in its life cycle and how confident you are in the company’s future to determine the right time.
A SWOT analysis can help you do just that. This is a framework companies use to make decisions based on a strategy’s strength, weaknesses, opportunities, and threats.
Again, as applied to your stock options, you can simplify a bit and evaluate based on opportunities and costs.
Opportunities will be the potential upside in dollars that you can gain from exercising or selling your stocks. As you consider this aspect, you’ll want to understand that the opportunity can be more or less valuable over time, depending on how the company performs.
Costs come in the form of the risk in dollars that you take when making a decision. Part of those costs are the cost to exercise, possible taxes owed, and the cost that comes if the stock underperforms the market.
3 Potential Stock Option Strategies for 3 Different Tech Employees
Make sure you consider when before proceeding. You can also work with a financial advisor who understands the complexities of stock options if you’re struggling to make objective (not emotional) evaluations of your company — and the opportunities and costs you might face.
Once you do that, there are the 3 stock option strategies to consider based on what kind of employee you are:
- Actively Accumulate: With this strategy, you’ll exercise ASAP and hold shares.
- Wait and See: This is a very simple strategy. It means don’t do anything — yet!
- Sell ASAP: With this strategy, you’ll cash out as fast as you can.
The right strategy for you will largely depend on what kind of tech employee you are. Let’s take a look at 3 common stages you might find yourself in to help you decide on your strategy.
Stock Option Strategies for the Early Employee
You’re an early employee if you were one of the first 50 employees at a company. Your stock options may be a combination of incentive stock options (ISO), non-qualified stock options (NQ), and restricted stock units (RSU).
If the company does an initial public offering (IPO), you could also potentially have an employee stock purchase plan (ESPP).
Your Opportunity: As an early employee, you’ll usually get a substantial number of options in your new hire grant. Startups can’t offer a lot of cash to the first employees, so they offer options and the possibility of huge upside.
Getting in at this early stage also means your options will have a low exercise (strike) price. This lowers the cost of exercising.
There are a lot of unknowns, but the potential upside is huge.
Your Strategy: In this situation, you’ll want to actively accumulate shares, which includes exercising your options early and often. Sell your RSUs immediately, and after the IPO, evaluate a buy-and-hold with an ESPP.
As far as when to start selling non-RSU shares, consider when you want to fund your goals. For example, consider if you want to buy a house, pay for your child’s college education, or start saving for retirement.
If you’re unsure when to sell or don’t have goals that need funding, use taxes as your guide.
There are usually optimal tax strategies, and sometimes there are a number of shares to sell before triggering some higher tax level. Work with your advisor and develop a multi-year tax plan as part of your stock option strategy.
Stock Option Strategies for the Late-Stage Tech Employee
If you landed anywhere between employee 50 and 1000, you’re a late-stage tech employee.
You’ll likely be in a company approaching an IPO, like an Uber, Lyft, Dropbox, Pinterest, or Airbnb. Your company completed multiple rounds of fundraising (could be on Series F or G) and new grants of equity will likely be in the form of RSUs.
Your faith in the company may be high, but your equity grants probably won’t be as robust. The most important thing to do in this situation is to avoid buying high or getting caught up in the cycle of a late-stage company getting lots of positive press.
Remember that for every Facebook, there are a thousand overhyped companies that have been forgotten as their share prices went on a never-ending fall.
Your Opportunity: A higher exercise price, increased fair market value, and a greater cost to exercise limit your opportunity somewhat. There’s also a higher possible tax bill.
Note, however, that this is less of a concern for ISO under new tax rules. With a higher alternative minimum tax (AMT) exemption and limit on state and local taxes (SALT), fewer people will owe AMT.
This means that you’ll be able to exercise more ISO before triggering the AMT. Check with your advisor to see exactly how this will affect you.
Your Strategy: Simply wait and see. The opportunity to exercise is diminished by higher costs. Wait for a trigger event, like an acquisition or IPO, to give you a better idea of the upside potential. In an IPO, be sure to take action before your lock-up expires.
Stock Option Strategies for the Fast-Track Executive
Whereas most employees need to change companies every few years to increase salary and career prospects, you’re on a course to move from Lead to Vice President to SVP to C-suite.
With each promotion, you get a higher salary and larger equity grants.
Your Opportunity: As your salary increases, setting aside more and more into savings can provide you with an increased risk capacity. You also get greater equity grants which means it’s easier to accumulate shares.
Your Strategy: Evaluate upside of the company’s stock, then choose to actively accumulate shares or sell ASAP. This will depend on the company’s prospects.
Let’s consider Tesla employees as an example. Actively accumulating shares would have been the correct strategy.
Since the company’s IPO in 2010, Tesla shares have increased 1,720 percent. (For reference, the Vanguard Total Stock ETF (VTI) was up 156% over the same period.)
Twitter employees, on the other hand, should have sold ASAP. Since the company’s IPO, Twitter shares have decreased 45% — even after increasing 31% in the last 12 months.
Over that same period, the Vanguard Total Stock ETF (VTI) was up 50%.
It is impossible to know what the future holds for your company. So much of a stock’s price is based not on what you know as an employee but on what millions of others think they know about your company. Evaluate your goals. Sell to fund goals before taking the extra risk of actively accumulating shares.
Base Your Strategy on Your Equity Type
In addition to using your employee type as a baseline to determine strategy, you could make a strategy based on equity type. Here’s what to consider, depending on what you hold:
ISOs: Actively accumulate shares and exercise the maximum number of shares without triggering the AMT.
NQs: Wait and see. Hold your options until the expiration date, then do one of the following:
- Exercise, pay taxes, and hold shares if you believe the share price will increase faster than the total stock market.
- Exercise and same-day sale if you believe the total stock market is a better investment.
RSUs: Sell ASAP! This is almost always the best strategy for RSU because you pay ordinary income tax on RSU when they vest.
As a result, there’s no tax advantage to holding; you might as well buy shares on open market.
But no matter what you decide to do, know that looking to your coworkers or friends who work for other tech companies is probably not the right move.
Your situation is unique and so much depends on where you’re at in the company, what you believe about the company, and the kind of equity you hold.
If you can’t determine the right stock option strategy, it might be time to think about working with a knowledgeable financial planner who can objectively consider all of the variables of your situation.
The more time you spend researching and developing a strategy, the more money you stand to gain in the long run.