Part 1 of 2
What the heck is an employee stock option?
Publicly traded companies may offer employees stock options as a form of incentive compensation. These options give you the right to purchase company stock at a specific price. There’s a lot of jargon to share when it comes to employee stock options.
The initial price, when you first receive an employee stock option, is called the grant, exercise, or strike price.
The employee stock options also have a vesting date and an expiration date.
The vesting date is when you can start exercising the options. To exercise an option, means to choose to purchase the stock at that specific price.
The expiration date is (duh) the date when the options expire, and you can no longer exercise them.
Why do companies do this?
Well, for one thing, if the company is a start-up, they may not have a lot of cash flow to offer employees high salaries. But they could issue employees shares of stock, and then, ideally, in the future, the company will take off and those shares could be worth a lot of money. Companies also use stock options as motivation. If an employee is issued shares of stock, they have an incentive to work hard to make the company profitable, which will increase (theoretically) the share price of the stock. Research shows (probably, I’m not quoting any stats here) that if the person has an ownership stake in something, then they will value it more/take it more seriously/work harder to make that stake grow.
How does it work?
Stock options work best when the market price of the stock is above the exercise/grant price. For example:
- I issue you stock options (shares) of Jill, Inc. with an exercise price of $10.
- The current market price of 1 Jill, Inc. share is $15.
- If you exercise (buy) the shares at $10, you can immediately sell them for $15 in the market, therefore making a profit of $5/share. Bam!
- The difference between the exercise price and market price is also called the spread.
There are 2 types of employee stock options, and they have different tax consequences.
- ISOs (Incentive Stock Options) which are usually only offered to executives/key people.
- NSOs (Non-qualified Stock Options or Non-Statutory Stock Options) which tend to more prevalent because they can be granted to employees at all levels, including consultants and board members.
When an employer grants you options, that is not considered a taxable event. It’s only when you DO something with them that you must pay attention and figure out if it is taxable or not. It can get complicated, so engaging an accountant may be a good idea.
As always, if you have questions, feel free to email – Jill Carr
Disclosure
*Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by Stephens Consulting, LLC, doing business as Stephens Wealth Management Group (SWMG), or any non-investment related content, made reference to directly or indirectly in this newsletter will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful.
Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this newsletter serves as the receipt of, or as a substitute for, personalized investment advice from Stephens Consulting. Please remember that if you are a SWMG client, it remains your responsibility to advise us, in writing, if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services, or if you would like to impose, add, or to modify any reasonable restrictions to our investment advisory services. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to your individual situation, you are encouraged to consult with the professional advisor of your choosing.
SWMG is neither a law firm nor a certified public accounting firm and no portion of the newsletter content should be construed as legal or accounting advice. A copy of SWMG’s current written disclosure Brochure discussing our advisory services and fees is available for review upon request. Links are being provided for information purposes only. SWMG is not affiliated with and does not endorse, authorize, or sponsor any of the listed websites or their respective sponsors. SWMG is not responsible for the content of any website or the collection or use of information regarding any website’s users and/or members. Important Disclosure.
Please Note: Stephens Wealth Management Group does not make any representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information prepared by any unaffiliated third party, whether linked to SWMG’s website or newsletter or incorporated herein and takes no responsibility for any such content. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly.