Want to make sure you're setting yourself up for success with your stock options? Here are the 5 most common mistakes people make around their employee stock options and how to avoid them.
More and more companies are offering stock options as part of their compensation packages.
As an employee, this is an exciting prospect—and also intimidating. The world of equity is complicated, and the last thing you want to do is make a mistake that could devalue the compensation you worked so hard to receive. We spoke to Origin’s equity experts, who identified these most common pitfalls you should avoid regarding your stock options.
Editor’s note: Want to know more about equity and stock options? Download our free eBook to help you better understand employee equity compensation.
1. Not understanding equity compensation when hired
You just received an offer letter (hurray!), and you are being offered equity in addition to your base salary. It’s important to understand what you are actually being offered (shares of stocks, or options to buy shares of stocks), when you vest (or, when you’ll receive the equity), and what the value of equity is.
Without this basic understanding, you may get hit with a surprise tax bill or not receive the full value of your equity down the line. Here are some steps you can take to educate yourself:
Do your own research
Going into salary negotiations with some knowledge about stock options can be incredibly empowering. Start with the basic terminology and write down questions about anything you don’t understand.
If you want to further your research, check out this post about equity compensation.
Don’t be afraid to ask the HR team questions about your equity.
Some of those questions might be:
- What type of equity am I receiving?
- What percentage of the company’s equity do the options granted represent?
- What is the strike price?
- What is the vesting schedule?
- What’s the most recent valuation of the company?
- What happens if the company is sold?
- How do you exercise your options?
- What are the tax implications?
These are all things your employer should be able to address.
Negotiate on your terms
Once you have all the information in hand, make negotiations based on what you feel is in your best interests.
For instance, if you don’t think more stock options are the best option for your current situation because you can’t afford to purchase them or the tax implications would be too great, ask for a higher base salary.
The most important part is to make an informed decision based on your needs.
2. Failing to read the plan document
When a company initially sets up its stock option program, they have to create a document called a stock plan. This outlines the guidelines for how options are granted, how they work, and what the option holder needs to know.
Reviewing this plan document is critical to getting the most out of your equity. It’ll include information that can help you exercise your options correctly (and within the legal bounds) and help you better prepare for taxes.
Take the time to read through the stock plan, ask clarifying questions, and review it regularly.
3. Letting your options expire
Unfortunately, many employees let their stock options expire. There are two ways this could happen:
- You miss the exercise period. Most companies typically provide a time period within which you should exercise your options (usually around 10 years). If they’re not exercised in this timeframe, they expire.
- You leave the company. If you leave your company for a new job, get laid off, or retire, you typically have a window of 90 days to exercise your options. If they’re not exercised in this timeframe, they expire.
Here’s an example: you receive Incentive Stock Options (ISOs) with a four-year vesting schedule and a one-year cliff. With this schedule, you own zero options in your first year of service. After your first year with the company, you’ll receive 25% of the options you were granted and then incrementally more every month until they reach four years.
However, if you leave the company before the four years, you lose any unvested options. And if you don’t exercise the options you do have within 90 days, you’ll lose all economic benefits.
4. Not planning for taxes
Stock options have tax implications. And it’s important to understand and plan for these expenses ahead of time so that you’re not caught off guard when the bill comes.
Let’s use another example: when you exercise your ISOs, they’re not subject to income tax. Great news, right? Not so fast.
The bargain element, which is the spread between the strike price and fair market value of the stock at exercise, is subject to the alternative minimum tax (AMT) on exercise.
To estimate how much you may owe, you can either complete the IRS Form 6251 or do an internet search for an online calculator. However, calculating AMT can be very complex, so employees who are granted ISOs are generally advised to consult with a qualified financial professional.
Being aware of the tax implications of your stock options can save you a lot of time and trouble down the road. If you want to understand how different types of equity are taxed, you can download our equity compensation guide.
5. Not consulting a financial advisor
As you can tell, navigating equity compensation is hard. We encourage employees to consult with a financial advisor who can help them understand the ins and outs of their stock options.
However, if you’re like most people and don’t have access to a financial advisor, ask your employee to introduce Origin as a benefit. Our Equity Manager product contains a suite of tools that allows you to get a comprehensive overview of your equity, educate yourself, and even simulate the value of your compensation over time.
Our platform, paired with personalized guidance from our network of CFP® professionals, will empower you to make the most informed and confident decisions possible around your equity compensation.
Navigating the world of equity compensation is far from easy. But hopefully, this article made you aware of some of the most common mistakes employees tend to make with their stock options. With a bit of research, support from your employer, and the right tools, you’ll be able to make informed decisions about your equity moving forward. If you think Origin would be a great fit for your company, ask your HR team to request a demo.
If you want to learn more about equity compensation, we recommend reading Equity 101 for HR managers: The most common questions about employee equity answered, How to educate your employees on equity compensation, and our free eBook An HR leader's guide to understanding employee equity compensation.