Who works for a tech company that offers stock options? Besides me?
It’s a very common benefit nowadays for companies to offer this to their employees.
To attract and retain the best employees.
After all, it is very costly to hire a new employee.
Google it right now if you don’t believe me.
So besides the usual benefits like health/dental/vision insurance, commuter benefits and sometimes even life insurance. You now have stock options.
Here’s the reason why I wanted to write about this.
I feel like many individuals miss out on the potential income of these benefits.
And someone I knew well at work missed out a LOT.
So much that it inspired me to write this post.
If you feel like you have a pretty good grasp on stock options, feel free to jump around.
But for the others, let’s start at the beginning!
TABLE OF CONTENTS
1. What are Employee Stock Options?
Congratulations! You probably just got an offer letter from a tech company that offers these benefits.
And you may have heard that it’s a GREAT benefit but what exactly are they?
And why should you care?
I hope you’re excited, because I’ll walk you through it.
In the simplest terms, it’s an opportunity to buy ownership of a company.
Tech companies want to attract and retain the brightest and most hard-working employees so guess what?
They give you an opportunity to own pieces of a company.
And the pieces of a company are usually referred to as shares.
But hold on, I thought we were discussing stock options?
Yep and you may have just missed it. They’re an opportunity to own pieces of a company.
Why an opportunity and not the ACTUAL shares?
The companies do it this way so they can lower their risk.
Because they just spent so much time.
Interviewing the right candidate and investing the time to see if you’re the best fit for them and their culture.
So of course, the shares aren’t offered to you right away.
It’s almost like you have to earn it.
But don’t worry, you don’t actually have to do anything.
After all, you passed with flying colors and received the offer letter.
So it’s more of a waiting period.
Which leads into the actual benefit letter!
How to Read Your Stock Offer Letter
It really depends who you get hired by but the offer letter is usually a few pages if not more.
There’s a welcome/introduction about who you are working with/for, how much you get paid, your job title etc.
But what I really want to focus on is the stock offer piece of it.
No matter how long this piece is, it should give you a few pieces of information.
With some fancy terms thrown in.
Here’s an example of a stock offer letter with the information we’re interested in.
We will go over these terms in just a second.
And don’t worry if you don’t have all of these terms in your offer letter.
You can always check in with the HR department at your company for clarification.
Stock Options Lingo
Let’s try to break these terms down.
First off, vesting.
What is Vesting?
Remember the waiting period I mentioned earlier?
That’s essentially vesting.
You want the formal definition?
Okay, here you go.
It is the period of time before an employee can own the shares from the stock options.
The typical phrase in the offer letter goes like this:
Four year vesting schedule with a one year cliff.
I’ve been offered stock options TWICE in my career and this phrase was always the same.
So what does this mean?
I’ll try to make this as simple as possible.
You can buy all of your allotted shares within 4 years. Unless you get more.
So the first year you can buy up to 25% of your total allocation.
And the rest gets spread out over the next 3 years.
Is that still confusing?
Let’s use a simple example.
Take 1,000 shares.
Once you reach your 1 year anniversary with your company, you can buy 250 shares. (1,000 times 25%).
And you don’t need to buy them all at once. The window of opportunity opens so you are eligible to purchase these shares.
Then you can buy the remaining 750 shares in the next 3 years.
But you won’t have to buy it on a yearly basis.
It turns into monthly.
Probably because if an employee has stuck around for a year, they are likely to remain at the company longer.
But don’t quote me on this as each company may vary in their stock program.
Okay, on to the next term!
Exercise Price aka Strike Price
We’re not talking about bowling.
Or holding up signs to voice out opinions.
We’re still discussing stock options.
You don’t have the shares yet.
The letter initially describes when you can buy the shares.
So the next question is how much are they?
In other words, the strike price. Or exercise price.
Whichever you prefer to call it.
But it depends on what type of company the options are from.
Public Company vs Private Company
For a public company, the strike price was determined when you got the letter.
It should be listed on there. For example, $10/share.
If not, contact your HR department because I can’t help you further than this.
For a private company, the board of directors vote on what THEY think the price should be.
And usually the board of directors meet every quarter.
Once they vote, the price will be announced to the employees.
No matter if your company is private or public, you should be aware of what your strike price is.
2. Types of Stock Options
Did you know that there are actually TWO common types of stock options offered to employees?
One is highly more lucrative and I’ll explain WHY.
ESOPs vs RSUs
Up until this point, I’ve been referring to ESOPs (Employee Stock Ownership Plans) because these are offered within the offer letter.
If you remember the earlier terms, these have a vesting period and a strike price.
The hope is you join the company early enough that the strike price is below the market price so you can make additional money.
Because your profit is market price MINUS strike price.
But what if you did not?
Then you stay at the company in hopes that the stock price will rise OR you leave the company.
There’s also RSUs (Restricted Stock Units).
These are the highly lucrative ones I just mentioned.
Because they have NO STRIKE PRICE.
Once they vest, you own them. So the profit margins are much higher.
In other words, the strike price is zero.
Don’t get too excited though. RSUs are typically offered for promotions because they are so valuable.
If you have them, take advantage of it!
3. Don’t Lose Out on the Extra Money
Now I want to take a moment to explain WHY I am writing this.
Because I was also brand new to this benefit just like everyone else at one point.
So I mentioned at the beginning that I knew someone who missed out a LOT.
Because she didn’t know anything about stock options.
She was very fortunate to join a startup at its earliest stages.
Therefore, her strike price at the time was SUPER low.
Like less than a dollar.
She did the time, stayed until everything vested but she didn’t do anything with them.
Because no one told her how.
Even though the price peaked one time over $60!!!!!
Quick calculation suggests this would have been over 600% profit or close to it!!
So I was working with her at the time and encouraged her to take advantage of them.
But she hesitated due to FEAR.
And then when I decided to leave the company.
Her company got acquired and her team was laid off.
In addition, she lost ALL of her options.
If she bought some shares then they would be transferred over.
But she didn’t.
She lost out on so much potential money.
Even if it wasn’t enough to leave work for a few months.
So DON’T LET THIS HAPPEN TO YOU!
It’s just like losing out on extra money!
4. Making Money With Your Stock Options
Hopefully you can relate to the pain I felt when thinking about that person’s particular loss.
Especially since she joined in the early stages of a company.
She’s still working though. At another company, but I think it was such a pity.
That being said, I want to educate YOU so you don’t miss out on this additional income.
So let’s move into the details about how this actually works.
How to Buy/Sell with Stock Options
It all starts with a stock broker.
If your company has one to manage the stock options.
Otherwise, there will be another type of provider to handle them.
You first setup your account with the stock broker. (This could be a special link through your employer to sync to the broker.)
And within your account (after a few days or so), you will see an account that refers to Employee Options.
It should be in the name somewhere. Another common name would be Stock Plan.
To make it obvious that this account is for those options.
Depending on how the broker works, you can fund your account through ACH, wire or other methods.
And once you have money in the account, it works just like any other stock account.
You execute an order to buy the options once they are available.
And sell them if the options are available to the public.
Any proceeds from the transaction will be dropped back into the account.
But if your company is still private, you cannot do that.
You can either wait for the day your company goes public or check if they have a stock buyback plan.
The latter option is for employees planning to leave a company when they still have shares.
As you can see, owning shares of a private company can be risky. It really depends if the company is large enough to go public.
And now for the part everyone hates.
5. Taxes You May Need to Consider
I’ll touch upon this briefly because I am NOT a tax professional. (And I don’t want to give you the wrong advice.)
Because there are tax professionals who are more experienced with this topic.
So please take this advice with a grain of salt.
And consult a tax professional for any specific questions.
I wanted to touch on this briefly because there can be tax implications when exercising a lot of those options.
To the point where you may need to pay additional taxes.
But it all depends on the time period in which you buy and sell.
Which brings me to my next topic…
Short-Term vs Long-Term Capital Gains Tax
Do you know what the difference is?
Short term is when the buying and selling happens in LESS than a year.
Long term is the opposite.
It may seem like a small difference but it heavily impacts the tax rate.
You can look up the rates but generally, short term tax rate is HIGHER than long term.
So please keep this in mind as you buy and sell these stock options.
You wouldn’t want to create additional taxes for yourself if you don’t have to.
Or be surprised with a bigger tax bill at the end of the year.
Thanks for reading this post. I hope this was helpful in clarifying stock options for employees.
P.S. If you haven’t started with your own personal finances and need a little more help. Read my 3 Easy Personal Finance Tips.