Most companies offer stocks or stock options as incentives. Start-ups regularly use stock options as part of their compensation package. Over the years, many of our candidates have greatly profited working with start-ups that eventually became public multi-billion companies. The following article provides insights as to how to consider accepting stock options.
Originally Published December 03, 2013, 03:12:26 PM EDT
Does your new job offer stock options to you? For many it’s a great incentive to join a new company. Google (NASDAQ: GOOG) has to be the highest-profile example, with the legendary stories of thousands of original employees becoming multi-millionaires, including the in-house masseuse. Below is some information to help you understand stock options a little better if you’re confused about how they work.
How stock options work
Though employee stock options have lost a bit of their luster since the global financial meltdown — being replaced more and more by restricted stock — options still account for nearly one-third of the value of executive incentive packages, according to compensation consulting firm James F. Reda & Associates. Want stock options? You’re going to find them harder to find these days, mainly due to changes in the tax laws and recent blow-back from employees working for companies battered by the recession and tired of holding out-of-the-money, worthless options. In fact, employee stock options peaked in popularity back in 1999.
But if you score a gig with options, here’s how it will work.
Being granted stock options gives you the right to buy your company’s stock for a set price at a future date and for a specified time. We’ll use GOOG as an example.
Let’s say you were among those lucky “Nooglers” hired back when GOOG was issuing stock options at $500. You get the right to buy 1000 shares at $500 (the grant price) after two years (the vesting period) and you have ten years to exercise the options (buy the shares).
If Google’s stock price is under $500 when your shares are vested they are out of the money and you’re out of luck. You don’t have to buy the shares at a loss, they just expire worthless, unless the stock rebounds and gets above its strike price — or if the company generously decides to revalue the original exercise price.
But if GOOG is over $1000, as it is now, crack open the champagne – you’re in the money! You can buy 1000 shares at $500, then sell them and pocket a half million dollar profit. Just watch out for the ensuing tax bill.
In some cases, you can exercise your options and then hold on to the stock for at least a year before selling them and pay a lower tax rate. Options have a bunch of tax consequences to consider. If you have questions about your stock options, ask an advisor.
The downside of employee stock options:
In spite of that fact that options can make millionaires out of masseuses, there are some downsides:
Stock options can be a bit complicated. For example, different kinds of stock options have different tax consequences. There are non-qualified options and incentive stock options (ISOs), both having specific tax triggers.
Options can expire worthless. Imagine the thrill of a grant followed by the agony of a stock flop. Rather than acting as an employee incentive, options issued for a stumbling stock can muck-up morale.
Knowing when and how to exercise stock options can be nerve wracking. Has the stock reached its peak? Will it ever rebound from historic lows? Exercise and hold – or exercise and sell?
And you can get way too invested in company stock. Holding a heap of options can lead to a windfall or a downfall. You just can’t bank on them until they’re in the money and in your pocket.
Employee stock options can be an extraordinary wealth-builder. With a rising company stock price and a vesting ladder, it’s almost like a forced savings account. And that can be an option worth taking.