5 Key Decisions to Make About Stock Options

by | Jan 26, 2018 | Stock Options, Tax Planning, Tech Industry

5 Key Decisions to Make About Stock Options

by | Jan 26, 2018 | Stock Options, Tax Planning, Tech Industry

emplpyee stock options

Have stock options? If you play your cards right, you can turn that perk of your job into a significant amount of cash.

Doing so requires a lot more than just guesswork and you definitely need to think rationally through the decision-making process.

If you act emotionally or just don’t know what to do to maximize your potential assets, you could miss out on a great opportunity.

Don’t be the one at your company who misses out — or makes a silly financial mistake with your shares. These are 5 key decisions you’ll need to make about your stock options to make the most of them.

1. Negotiate Stock Options as Compensation

You need to have access to stock options before you get to leverage them, right? If you’re interested in a way to diversify your income beyond just the paycheck you receive, you could negotiate for options when you take on a new position.

You can do this at both public companies and startups. To establish a baseline for your negotiations, start by evaluating your financial needs and determining what you’re willing to give up or be flexible on.

This doesn’t mean you just roll over in a negotiation. It means identifying what is a “must-have” for you, versus what you’re willing to give up in exchange for that must-have.

Does your financial situation allow you to take a lower salary in exchange for options? You may have the ability, for example, to request a lot of options and little cash, go half and half, or get a few options and lots of cash.

And think about the company itself, too. If you don’t believe in its untapped growth potential, giving up a lot of salary in exchange for more options isn’t worthwhile.

Side Note: What You Need to Know about Negotiating Stock Options at Non-Public Companies with Billion Dollar Plus Valuations, Versus Negotiating with Public Companies

Companies like Uber, Airbnb, Dropbox, and Pinterest have a problem. When it comes to attracting talent, they’re at a disadvantage versus new startups.

That’s because they no longer have the relaxed startup work environment due to the pressure to meet expectations and perform in the market a certain way.These may feel like big companies — but they can’t offer the immediate liquidity of restricted stock options (RSUs) the way Microsoft, Facebook and Google can.

The result is that you have more bargaining power. For example, we’re seeing a $100,000 sign-on bonus and $1 million in equity grants for some new employees at these companies.

Negotiating stock options at public companies might look a little different, though. Companies like Google and Salesforce may offer more RSUs when you ask for a higher base.

Or they may accelerate your vesting to front load the offer with higher stock compensation in the first couple of years. Again, know what you want before you go into the discussion — and know the kind of company you’re dealing with.

Finally, another reminder: always ask for more.

2. Know When to Exercise Your Incentive Stock Options (ISO)

It’s crucial to know when the right time is to exercise your options. If you exercise them earlier, you face more risk due to uncertainty and low valuation. The stock could become worthless and you will lose the cash you paid to exercise your options.

That said, that route could be better for taxes because of the smaller gap between your exercise price and the current fair market value (FMV) of the stock.

If you exercise options later, you still face risk because high valuations come with high tax bills. As such, you’ll want to look for “trigger events” that indicate when you should make a move.

Specifically, watch out for events that signal an upcoming increase in the stock’s FMV, including new fundraising rounds or an initial public offering (IPO).

You can also start the 12-month holding period for long-term capital gains in advance of the upcoming opportunity to sell.

Nonqualified stock options are different. Any exercise will trigger taxes on the difference between your exercise price and the fair market value. If you believe in the company and you plan to hold the shares, your best course is to wait until the expiration date, exercise, and hold.

3. Understand When to Sell (and Stick to It!)

This is the toughest decision to make: at some point, you have to guess at the future FMV of the company whose shares you hold.

The key here is not just understanding when to sell, but to know yourself.

What are your financial goals? Can you sell now to pay for something that’s more important to you than any future share price, no matter how high?

Here are some goals that might warrant selling sooner than later:

  • Paying off student loans
  • Buying a house
  • Fully funding another financial goal that gives you the chance to live more comfortably.

If you are holding shares and options, you must identify the FMV at which you will start selling. But don’t make the mistake of constantly raising that price.

What does that look like? A little something like this train of thought: “I’ll sell at $20, but if it goes to $30, I’ll sell at $40. Unless of course, it goes to $40, then I’ll sell at $50.”

Avoid this!

Because then if it drops down to $30 again, you’ll be thinking that it’ll come back. And if it keeps going down, you’ve lost big time.

Don’t get stuck! Set a selling price and stick with it.

4. Determine How Much Stock You Should Buy

You might get the opportunity to buy shares on an ongoing basis. Employee stock purchase plans (ESPPs) allow you to buy shares of the company’s stock at a discount.

If this is the case, you may want to maximize participation to get the discount and then sell as soon as possible. This in effect increases your take home pay. It’s similar to getting matching contributions on your 401(k).

Some companies, like Netflix, allow you to get stock options in lieu of some or all of your salary. In this case, target a price then increase or decrease your participation around that price.

If the stock’s FMV is below the targeted price, hold what you already have and increase participation to buy more. If it’s above the targeted price, however, sell and lower your participation.

5. Think About What the Stock Is Worth in the First Place

Inevitably, when someone learns what I do and the clients I work with, they’ll ask something like: So what do you think about Uber?

What they want to know is, essentially, how much will the stock be worth at some point in the future. Will it go up or down?

My response is always the same: I don’t know.

And you don’t know either! That’s what makes this tricky. At some point, you will have to guess to make final decisions about when to exercise, sell, and buy.

It’s better to consider your entire financial plan, look at what you believe about the company, and determine your risk tolerance before setting a price that acts as your “trigger.” When the stock hits that price, you sell no matter what and don’t look back.

Stock options can be a great way to supplement your income and build wealth. As a result, it’s critical that you know your strategy to make the best of your stock options.

There’s no way to predict future performance with certainty. But with the right plan, you can maximize your gains to meet your financial goals.

Since passing the Certified Financial Planner (CFP) exam in November 2009, Landon has dedicated himself to the needs of busy young professionals. Before joining KB Financial Advisors in 2012, Landon founded Cumberland Wealth Planners in 2010 to serve clients in Nashville, TN. Landon took over the On Your Way to Wealth program in 2014 to help KB Financial Advisors further expand their work with young tech professionals in San Francisco who have stock options.

When he’s not on a plane to San Francisco, Landon lives in Nashville, TN with his wife Melissa and their three children.

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