Stock options as compensation

But should you accept stock options in lieu of salary? Let's start by saying that there is no mathematical equation to help in determining the balance between salary and stock options. Sometimes referred to as employee stock options, or simply ESO's, they are granted by an employer, enabling the employee the right but not the obligation to purchase a certain number of shares at a specific price and at a specific point in time in the future. They're most commonly offered to managers and officer-level positions. Options usually have expiration dates.

If the options are not exercised by those dates, the options will expire and become worthless.

Employee Stock Options and How They Work

There is also a vesting period, after which the employee will have full ownership over the options. Vesting might occur over, say, five years. Vesting is a strategy that employers use to keep employees with the company for longer periods of time. The market value of the stock at the time the options become vested determine the value of the options. And naturally that can never be known at the time the options are granted.

After two years with the company, the employee is vested in another shares. If the options expire before that price is reached, they will become worthless. What makes those two words so dangerous? And "rumored" means that whether or not the company will actually go public is still subject to some speculation. Meanwhile, the fact that the event is not expected to take place for at least another year means that the stock doesn't even exist right now.

The options therefore represent a complete unknown. Due to market factors alone, there is always the risk of options becoming worthless, even with a well-established blue-chip company.

Executive Compensation Plans: How to Understand and Proceed with Restricted Stock and Stock Options

All that needs to happen is for the market price of the stock to fall below the exercise price of the option. The situation is of course much more problematic with a startup company. There's no way to know what the market reaction will be to the stock once it goes public. Though we hear of initial public offerings rocketing out of the starting gate and making the holders rich, stock prices fall at least as frequently.

Employee Stock Option Plans: A Guide for Canadian Startups | Ownr

That means that it's entirely possible that the salary the employee will give up in favor of stock options will never materialize. The employee will be betting that the future of this upstart will be very positive and the company's stock will be well received by the market. But if circumstances don't break in that direction, he could not only be at risk on his job but also on his projected investment in the company's stock.

If this person is going to receive a paycheck from this company, his income is already going to be largely dependent on the fortunes of the company. Just because it's well-known and 'rumored' to go public, doesn't mean that it will happen — there's no guarantee the company will even exist 18 months from now. Stock options are an excellent benefit — if there is no cost to the employee in the form of reduced salary or benefits. In that situation, the employee will win if the stock price rises above the exercise price once the options are vested.

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And if the value of the stock never reaches the exercise price, the employee loses nothing. But that's not the situation with this startup employer. The best strategy for this employee is to negotiate a market-level salary. That will eliminate the risk of the many variables connected with the options, such as if the company will actually go public, how well-received the stock will be when it does, the exercise price level of the options, and what the vesting schedule might be. These are all variables that cannot be adequately factored into the decision at this point.

How to understand stock options in your job offer

Go with the market-level salary, and negotiate for the stock options as a secondary consideration. This post is part of a continuing series that answers all of your questions related to personal finance. Have your own question? Email yourmoney[at]businessinsider[dot]com. Jeff is an Iraqi combat veteran having served in the Army National Guard for nine years, including a 17 month deployment to Iraq in He is the founder of GoodFinancialCents.

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Car insurance. Life insurance. Best cheap car insurance. Best life insurance companies. This means that after the first year, you will be eligible to exercise, or purchase, shares of the total 1, shares of stock, with an additional shares vesting each year thereafter. To be clear, you do not have to exercise your stock options upon vesting. Most employee stock options come with an expiration date, allowing you to exercise your options at any point before the expiration date as long as the shares have vested. If you decide to exercise your stock options, you have a couple of different options to pay for them.

Employees who plan on electing this option usually put away money each year to cover the cost, as they already know how much their options will cost to exercise. Another option is to exercise your stock and immediately sell enough shares to cover the purchase price. Some employees choose to exercise their stock options and sell all of their shares immediately to pocket their gains.

This can be a way to recognize the profit on your option grant and receive cash, but you will no longer hold the stock, potentially forgoing future growth. Our financial planners and tax experts can help you explore alternatives for exercising your stock options and help you plan for your future. Reach out to our team to get started. As a hematopathologist, Steven Kussick focuses on blood-related cancers such as lymphoma. The Treasury Department and the IRS announced that the federal tax filing deadline for individuals has been extended to May 17, Employers can reduce risk and streamline the operations of their retirement plan by sweeping small k accounts of former employees.

Please remember that past performance may not be indicative of future results. Moreover, you should not assume that any discussion or information contained on this blog serves as the receipt of, or as a substitute for, personalized investment advice from Brighton Jones LLC. Brighton Jones LLC is neither a law firm nor a certified public accounting firm and no portion of the blog content should be construed as legal or accounting advice.

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