Where to Start When You Have Stock Compensation
Before I became a financial planner, I worked in the corporate world. During my first annual review with one company, my boss told me I was receiving an RSU grant. He handed me a piece of paper with some numbers on it. I just nodded my head like I totally knew what he was talking about because he acted like this was a good thing. Have you ever done that, so you didn’t look stupid? Me too.
As it turned out, I left that company before my RSUs vested (so they ended up being worthless). It didn’t matter that I didn’t understand all the details. However, I knew enough to know that I had lost something of value. When I negotiated my salary and sign-on bonus in my next job, I factored that in. Would it had made a difference had I known more what I was doing?
Maybe, maybe not. But it got me thinking about how many clients and prospective clients don’t understand the equity (stock) compensation they have in their current job. Or they get an offer letter for a new job, and they want us to review it. Even for those who understand in theory WHAT an RSU or an ISO is, they often don’t know what to DO.
As usual, Googling your question will get you ALL the answers. You just won’t know which one is correct and how it applies to you! My hope is that this blog post gives you an overview of types of equity/stock compensation you may have, and how to think about it. (It’s also possible that you may own company stock as part of your retirement plan or participate in an ESOP, but that’s not what I’m covering here.)
How do I get equity?
In general, there are two main “flavors” of equity or stock compensation. The first flavor includes actual shares of stock today, or in the future, either given or purchased at a discount. This includes RSUs (Restricted Stock Units), Restricted Stock Awards, and Employee Stock Purchase Plans (ESPPs). The second flavor includes giving you a choice (“option”) to purchase shares of stock in the future at some price point. This includes ISOs (Incentive Stock Options) and Nonqualified Stock Options.
It’s possible that your company only offers one or two types of this kind of stock compensation. Or they may offer one kind to new hires, and another as a performance reward. As you move up the corporate ladder your compensation structure may grow more complex.
It is also important to understand that this equity or option may not be something you can turn into cash right now (or ever). Often you need to wait, or hit some performance metric, for the equity or option to “vest”. Even after it vests, you may still have restrictions on what you can do with your stock or option like lockup times or blackout periods. If you receive options, you may need to come up with cash to purchase the shares of stock.
If your company is private (the stock is not publicly traded on an exchange), you may have to wait for a “liquidity event” or IPO (Initial Public Offering). Private companies may have even more restrictions on transferring shares or options you may be subject to. That’s why it’s important to know what type of equity compensation you have and the rules around it.
What type of stock compensation do I have?
When you get offered a new job or receive equity compensation at your current job, the company is required to provide documentation explaining what they are offering you. The document could be an award letter, a grant letter, an option agreement, or something else. Regardless of what they call it, you’re looking for the document that tells you what type you have, how much you have, and other rules that apply to you (vesting schedules and other restrictions). You may also want to understand if it’s part of an overall stock plan for the company and look at any rules contained in the stock plan summary or “prospectus”.
If you look at these documents and think “Whaaa??”, you are not alone. Many clients have come to us specifically for help in understanding what they have and what they should do about it. There is rarely an instruction manual provided by your company. Most employers are not in the business of giving you tax or investment advice.
There’s not one “right” answer for everyone. Also, the right answer for any one person may change depending on what kind of equity they get and what stage of life they are at. How are you supposed to figure this out? This is where a partner like Cultivating Wealth can help.
We can help you gather appropriate documentation to answer this question. For example, we often get clients who say they have shares of stock from an ESPP plan when in fact the shares were part of an RSU grant. We’ve seen situations where a client thinks they have ISOs and instead they turn out to be Nonqualified Stock Options. We can sit down with you to review the documents, and help you find what we’re looking for when you log into your company portal.
How much is this decision worth?
Now that you know what you have, you may need to make some decisions:
You need to decide whether to enroll in an ESPP plan, for example.
You need to decide when (or if) to exercise a stock option.
You need to decide when (or if) to sell your RSUs when they vest.
When cold hard cash is at stake, it’s easier to decide. If someone asked you if you want $1 or $2, you’d pick $2. It becomes more complicated when you must compare a higher salary from job offer with stock options from another. If both companies are offering options, how do you know which offer is more valuable?
It’s less important to make the “right” decision if going in one direction or another doesn’t have a long-term effect on your financial success. But for many people, making optimal, informed decisions about this part of their compensation can change their lives. It can make a difference as to when they can retire, or whether they can meet their other financial goals like buying a house or sending their kids to the college of their choice.
We help clients understand their choices – the financial implications of the choice, and the emotional ones. It’s often the emotional or qualitative aspects to the decision that make it most difficult.
How do you think about risk?
Are you the type to gamble or does losing money keep you up at night? Are you optimistic about the trajectory of your company stock? You may not want to put all your eggs in the company basket. The “right” decision for one person might be totally different from another’s depending on how they view the risk of investing where you work.
Often, people feel very emotional about investing in their company. It’s hard for them to be objective and treat this investment like others they are considering. It’s easy for them to imagine their stock continuing to rise. They may not appreciate the downside risk.
Your risk also depends on how much you’ve already invested in your company. If you’re just starting out, and don’t have a lot of assets, it’s not as big of a risk to invest in one single stock. Over time, you may have amassed a large chunk of your wealth in company stock. The more you have, the more swings in stock can affect you. It can also be difficult to sell when the stock may have dropped from recent highs. We help clients make these tough decisions by putting a plan in place that helps take the emotion out of each individual decision.
What’s your tax situation?
Almost all the decisions to be made around equity/stock compensation have tax consequences. It may not be possible to make the most tax-optimal choice because you can’t predict the future. It’s hard to compare what’s best today with what might be better in the future. It’s also hard to make the “right” decision from a tax perspective if it leads to more risky investments over the long term.
On the other hand, some people hate paying taxes so much that they put off any action that leads to paying them, even to their detriment. Doing nothing is a choice. It can lead to missed opportunities to build wealth or mitigate risk. In general, we help clients balance tax impacts with investment risk.
The worst tax situations involve paying taxes when you don’t have to, paying more taxes than you had to, or being surprised by a big tax bill that you didn’t plan for.
At the end of the day, having additional compensation offered by your company is a good thing! It can help you build wealth, and literally be more invested in helping your company succeed. However, it doesn’t come with simple-to-follow instructions. It requires you to learn what you have, understand the financial impact of it, and appropriately consider your appetite for investment risk and tax consequences.
Register for our introductory webinar where we talk more above these topics. Stay tuned for the rest of the posts in this series where we provide details on Employee Stock Purchase Plans (ESPPs), Restricted Stock Units (RSUs), Incentive Stock Options (ISOs), and Non-Qualified Stock Options (NSOs). Reach out to us if you need assistance in these areas!