You work very hard to drive company performance, and your success and achievements provide additional compensation through your company’s equity-based compensation plan. Unfortunately, this method of compensation adds complexity that must be fully appreciated not only by you, the employee, but also by your spouse or other people with whom you share your life. Our careers provide significant living opportunities, and equity-based compensation is a powerful part of the way executives are rewarded. Importantly, you will need to be prepared for the many decisions that come with the grant of company stock and options.
Our firm provides equity compensation guidance to our corporate-executive clients who have substantial — and typically concentrated — stock and options holdings in their companies. While these clients benefit from our comprehensive financial planning services, we also analyze and advise on ways to maximize the value of stock and options compensation while seeking to minimize the investment risks inherent in these focused equity positions. There is risk and reward associated with the granting of shares and options, and why, how and when diversifying into focused equities can lead to a better wealth-creation outcome. In short, the goal of stock and options monetization is to maximize after-tax value and minimize risk by our clients.
We discuss not only strategies for best selling a company’s stock or exercising options, but the associated potential tax implications and complications. We work with your accountant or tax attorney to provide guidance on the use of tax-advantaged strategies that are sometimes available to recipients of corporate stock and options grants. As a corporate executive with us as an understanding of their grant summary statement and vesting schedule, information about previously owned company shares, tax situations, and other personal assets and liabilities, we provide a comprehensive personal equity compensation Produce profile report which provides important insights related to one. Individual’s company stock and options.
There are five sections in the Equity Compensation Report:
- Stock Option Valuation: Includes in-the-money value, cash-out value, full option value and option profit value
- Company Stock Holdings: Value Restricted/Performance Stock Grants, Owned Shares, and Total Forfeiture Value
- Investment Risk/Reward: Refers to the upward and downward leverage in one’s holdings
- Personal Risk/Reward: Includes financial target, concentration, and value at risk (VAR) analysis
- Decision Framework: Identifies considerations for making informed diversification decisions about vested options and shares owned
Consequences relating to equity compensation are five important things a corporate executive should know, and which the customized report will explain in detail – Forfeiture Value.Leverage, Insight Ratio, Concentration, and Financial Goal Achievement.
Equity Compensation Fundamentals
While equity compensation comes in various forms, equity awards generally come in two flavors: grant of shares and grant of options.
Grants of shares are often called restricted stock units or performance shares, and are also subject to a vesting schedule. Vesting may take place over a number of years, and/or the shares may vest depending on the company’s performance. When restricted stock or performance shares are vested, they are taxed as ordinary income, and then subsequent growth is given long-term capital gains tax treatment if the shares are held for one year or more. .
Employee stock options give the employee the right — but not the obligation — to purchase stock in the company at a predetermined price (that price is often called the strike price, grant price, or exercise price). The vesting program for options typically lasts no longer than 3 or 4 years, and the right to purchase typically expires in 7 to 10 years. The tax impact will depend on the type of option — whether incentive stock options (ISOs) or non-qualified stock options (NQSOs), which you can learn more about. Here,
Tax issues clearly come into play in the case of both stock and option grants. Because of stock vesting and/or exercise of option grants, income may be concentrated in one tax year, requiring tax-advantaged planning (likeThere may even be tax-planning issues such as when/how to structure charitable gifts to optimize deductions over a multi-year period), and some clients have to pay additional taxes due to their equity-based income. It will also require careful planning of your cash flow.
5 things every executive should know about their employer stocks and options
- value package, forfeited value That equity is the value that the employee would lose by leaving the company before retirement. This amount includes all stock-based rewards. Another way to see Forfeit Value There is an opportunity cost incurred on leaving the company. a component of forfeiture value Which we include is the “time value” of the company’s hard to calculate options. We do this calculation using the Black-Scholes-Merton option pricing calculator. forfeited value An estimate of options is an estimate of what will be left if the executive leaves the company. This value excludes the in-the-money value of vested options as anyone would be able to exercise them prior to exit. However, by exercising vested options, the remaining time value of the option is discarded. In addition, the full option value of the uninvested options — intrinsic value plus time value — is forfeited upon leaving, as is the value of any restricted or performing stock. In short, the total forfeiture value This includes the time value of vested options, the full option value of the uninvested options, and the full value of the employee’s restricted and performance stock grants.
- Take advantage of: Our comprehensive report will outline the up and down equity values on various hypothetical price increases. To fully explain and appreciate an executive’s equity compensation, we make a key distinction between implied leverage in stock options versus lack of leverage in owned shares and restricted or performing stock grants. The leverage effect means that (depending on the option’s description) a given percentage change in a company’s stock price can mean a significantly higher percentage gain or loss in one’s options portfolio. Our report also presents this idea with useful graphics. Conversely, the incremental change in the value of a stock always remains the same as the incremental change in the price of the company’s stock.
- Insight Ratio: This ratio helps the executive decide when to exercise employee stock options and sell the shares. The insight ratio also helps in deciding which piece of vested options to sell. Again, we use the Black-Scholes Merton option pricing calculator, as the insight ratio is the time value of the option divided by the absolute option price for each vested option. In a nutshell, the insight ratio is the percentage of the time value compared to the intrinsic (in-the-money) value in each grant. As the option moves closer to expiration, or the option goes deeper in the money, the time value of the option will decrease and thus the insight ratio will decrease. If an option has a low insight ratio, it means that most of it has in-the-money value. For example, a ratio of 7% means that 93% of the full value of the option is in-the-money value, which is at risk by continuing to exercise the option. Typically, options with a low insight ratio are the best and first candidates for exercise and sale.
- Concentration: The assets associated with corporate stock and options awards are often an important component in achieving one’s financial goals, but there are risks associated with concentrated positions in company stocks and options. In our equity compensation report, we show the overall asset allocation that includes the value of one’s diversified portfolio (assets other than company stocks and options), as well as the gross (pre-tax) value of any company shares owned. Vested and Non-Vested Stock Options, and Restricted/Performance Stock Rewards. The relationship between the gross values of company stock and options and the value of a diversified portfolio represents the degree to which funds are concentrated. With a highly concentrated position, a drop in the share price of the executive’s company can have a disastrous effect on the net worth.
- Financial Goal Achievement: Our report includes a section designed to provide context about the role of a company’s stocks and options in achieving personal and family financial goals. An important financial goal is achieved when a low-risk investment portfolio is established, a portfolio that contains the funds needed to meet individual and family needs. The question of financial goal entertainment can carry risk with company stocks and options. For example, if financial goals have already been achieved, one may take on higher risks with options, perhaps holding them until they expire. Conversely, if your targets are not yet protected, it may be important to exercise options to lock in the in-the-money value of the options.
Expert equity compensation guidance should focus on ways to maximize the value of stock and option compensation, as well as minimize the investment risks inherent in such concentrated equity positions. We provide this guidance in an effort to bring clarity and understanding, so that the executive can make informed decisions in the light of the opportunities and complexities of any tax.
Contact a member of the Wealthspire team To learn how we can work with you to provide customized planning and advice about your equity compensation, and to receive a one-page summary, read “5 Things You Should Know About Your Employer Stocks and Options”. I should know.”