Traditionally, employees were looking to go to the job that offered the most cash in hand. Salaries and bonuses were the primary forms of compensation for employees. However, as the tech boom brought more startups into the limelight, employees became interested in stock options.
No longer just an option for wealthy owners, many hardworking employees are now in the position to translate their work in the company into actual ownership.
What Are Employee Stock Options?
Employee stock options are a form of potential ownership given to employees in exchange for the labor provided to the company. Stock options allow employees to purchase stock in the company at a highly competitive rate.
Employee stock options are generally used to motivate an employee's performance by providing them with "skin in the game" and the chance to gain directly from their hard work.
An employee would gain if the stock price increased while holding the options. The grantee is a corporate executive or an employee. The grantee receives equity compensation in the form of employee stock options.
An important distinction is that employee stock options are not stock themself. They are only the option to purchase stock later on. They are typically subject to various conditions, the most notable of which is the term when vesting stock.
The vesting period is when an employee must wait before they exercise stock options. Employees are typically subject to a vesting period so that they employ a reason to continue performing well and remain with the organization. Vesting occurs according to a predetermined timeline established by the corporation at the time of option award.
Here is an article about employee stock options.
Types of Employee Stock Options
Most employee stock option plans typically fall into two different types:
- incentive stock options (ISOs)
- nonqualified stock options (NSOs)
Incentive stock options (ISOs), also known as statutory or qualified options, are often exclusively granted to senior personnel and top management. In many circumstances, they obtain favorable tax treatment since the IRS regards gains on such options as long-term capital gains.
Employees at various levels of a corporation, as well as board members and consultants, might be issued non-qualified stock options (NSOs). Profits from non-statutory stock options are treated as regular income and taxed accordingly.
A document for your employee stock option plan will explain the restrictions that apply to your options. Employees need to get a copy of the plan and contact a knowledgeable advisor to walk through the qualifications tied to the option.
Considering the investment risk, tax impact, and market volatility can help you tailor a choice that you feel comfortable with to fit your financial concerns.
Here is an article describing the types of employee stock options.
Terms To Understand in Your Employee Stock Options
Employee stock options can come in various forms as companies structure their equity compensation programs differently. Aside from NSOs and ISOs, there are other terms to be familiar with in reading and discussing your employee stock option plan.
- Restricted Stock Unit (RSU) plans. A restricted stock unit plan differs from a traditional employee stock option in granting an employee the right to purchase or receive shares after satisfying specified requirements RSUs may be given to employees who have worked for several years or reached performance benchmarks. In addition, unlike employee stock option plans, RSU stock plans do not have an exercise price. They may allow the employer to provide the value in actual cash.
- Stock Appreciation Rights (SARs). A stock appreciation right grants the employee the right to profit from a set number of company shares over a specified period of time. SAR plans may be payable in actual company stock or, similar to RSU plans, SAR plans might be paid out in real cash.
- Phantom Stock. A phantom stock agreement gives a future cash bonus equivalent to the value of a certain number of shares. There typically is no legal transfer of share ownership. Still, the phantom stock may be converted to genuine shares if certain trigger events occur. The phantom stock allows employees to gain the value of the stock increase while leaving the company with the stock ownership.
- Employee Stock Acquire Schemes. These plans allow employees to purchase company stock at a discount.
Here is an article about terms to understand in your employee stock options
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How To Review Your Employee Stock Options
Reviewing stock options can be overwhelming. Many employees who are not accustomed to going through equity exercise options may feel uncertain about how choices might affect their future plans. Employees, including you, should take comfort in knowing this is a good problem and one that can become by learning the basics and seeking professional advice.
Employee stock options all have one thing in common: they expire, and the time to act is limited whether you choose to exercise your stock options. Set aside some time to evaluate your decision.
Increased volatility in the value of your employee stock options might be caused by general stock market movements or particular public announcements at your firm. In addition, your stock options may do various things as the firm equity fluctuates with the stock market or on its own.
Seeing the value of your stock options fluctuate so fast may cause you to reconsider your initial strategy, but be sure to consider your long-term goals as unexpected and sudden volatility might be an indicator of only a short period.
Rather than focusing on your options' short-term price swings, turbulent periods are a good opportunity to revisit your long-term strategy. Price movements are frequently short-term, but your concentration is on the long-term. Allow your strategy to unfold or make important and deliberate changes as needed.
It may be beneficial to review how effectively your strategy has done thus far. For example, you may have disposed of a certain number of shares in accordance with your vesting and/or expiration schedule. Divesting shares is one strategy to avoid overly investing in your company's equity. It may also stretch your tax burden across several years instead of just one.
A mix of analyzing prior decisions and creating short and long-term goals is an excellent strategy to manage fear and anxiety that comes amid market turbulence.
Here is an article about reviewing your employee stock options.
Grant Price vs. Exercise Price
A grant is a cash reward granted by one entity (often a corporation, foundation, or government) to a person or a firm to help them achieve a goal or to incentivize performance. Some awards need waiting periods, known as lock-up or vesting periods, before the recipient may fully possess the cash incentive.
After the waiting period, the employee can exercise the stock options and purchase shares, frequently at a price lower than the company's current market value. In addition, actual shares of stock are sometimes provided and can be sold after a waiting period.
Employees are frequently given stock option grants after working for the firm for a certain amount of time. Each firm determines how its grant program works. Still, most of the time, workers must continue to work for the company and are not allowed to exercise their given options (sell their awarded shares) for a specific time.
Furthermore, grants often follow a vesting schedule in which rights to financial benefits accrue over time. For example, if employees stay with the firm, they get 50% vested in the incentive if they remain firm. At that moment, even if employment termination is needed, the employee has inalienable rights to half of the award.
From the perspective of the employer, the goal of a stock option award is to incentivize employees to align their interests with those of the shareholders. A stock option grant is a chance for an employee to acquire shares in the firm for which they work. The grant price is typically established at the market price when the grant is awarded.
If the stock's market price rises, the grant price remains unchanged. The employee purchases a stock at a lower price than market value while exercising the option. Grant prices are comparable to call options, except they do not have an expiration date.
When you are granted employee stock options in a private or public firm, your exercise price or strike price is the price at which you can acquire a specified number of shares. The exercise price is determined by the option's Fair Market Value when it is issued. It is crucial information regarding your employee stock options for two reasons.
The exercise price is utilized to calculate the monetary amount necessary to exercise your options and the tax consequences. To exercise your choices, you must pay the strike price multiplied by the number of vested options you desire to execute in return for your shares.
Taxes are then determined based on the difference between the stock's current Fair Market Value and your strike price. Taxes are assessed differently based on the Employee Stock Options awarded to you.
The workout price determines where you are in the money. If the current stock price is higher than your exercise price, your options have a positive value. Conversely, your possibilities are termed under-water if the current price is less than your exercise price. Often, the exercise price is less than the current trading price.
Here is an article about the difference between grant and exercise prices.
Should I Hire a Lawyer to Review My Stock Options Agreement?
Incentive stock options, non-qualified stock options, restricted stock, and phantom stock agreement may all seem like complicated terms to someone who does not regularly review employee stock option plans.
These terms and conditions are not difficult to grasp but have real-world consequences. For example, stock options may be an excellent benefit for a new employee, and hiring startup lawyers may be worth the cost to ensure you are set for high returns down the road.
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