It’s Your Money, Not Theirs

So you received stock options (or a grant of company stock, which is more rare)?  Good for you!  Options can be managed into a significant source of wealth – if properly handled and if the company performs well.  If those two conditions aren’t met, they are nearly worthless pieces of paper that may only make you feel good for a short time.

This is the cover of Empowered, which will release on October 12, 2014.  You can Preorder it for the Kindle by clicking here.

This is the cover of Empowered, which will release on October 12, 2014.  You can Preorder it for the Kindle by clicking here.

In this post I’ll provide some tips on how to handle stock options (and subsequent stock ownership) that should help you manage your options to maximum benefit.

Don’t celebrate just yet

Most stock options require a “vesting” period before they can be exercised.  A typical schedule for vesting would be over a three year period where one third of the options vest each year.  Another common way to handle this is “cliff” vesting, where 100% of the options vest at the end of a waiting period, usually somewhere between one and five years.  Until the options vest they are worthless, so don’t start celebrating just yet.

Many people see options as a reward for performing well, but that’s not why most of them are granted.  They are normally used as “golden handcuffs,” designed to keep you working for the company even though you might otherwise consider other alternatives.  Feel good about this – it provides insight into how you fit in the company’s future plans.

Check the fine print of your options.  Some will say that any unexercised options at the time employment ceases are forfeited.  Others may attach non-competes or other semi-related restrictions.  Be aware of these limitations and plan how you will handle them in the event of quitting, being terminated, or retiring.

When should I exercise?

Options typically have a limited life.  The ones I received were valid for ten years, but others may have a different (shorter) life.  Once the options vest, you can exercise them any time up to the limit of the life span of the option.

So when should you exercise?  Generally later is better as it gives the stock price a chance to more fully appreciate.  Options give you the right (but not the requirement) to purchase shares of the company at a historical price.  Assuming the stock price goes up, the longer you wait the larger the gain you’ll realize.

And the longer you can hold off paying taxes.

Taxes?  I have to pay taxes?

There are two types of options – Incentive stock options (ISO’s) and non-qualified options (NSO’s.)  ISOs are nice because you don’t have to pay taxes on them until you dispose of the acquired securities, and then it is all capital gains versus ordinary income (it does still hit you on the AMT schedule, so don’t get too excited if you have ISOs.)  This means that most people can exercise whenever they think the timing is best without having to worry about the tax impact.   With NSOs your gain on exercise becomes ORDINARY INCOME for tax purposes.  Any subsequent gain (or loss) upon sale of the acquired shares is treated as capital gains.

Most companies seem to grant NSOs because corporate tax deductibility is difficult or impossible for ISOs.

When you decide to exercise, there are a few options of how to handle the transaction.  You can pay cash for the options at the “strike” price (from your savings, a bank loan, or another source) and collect your shares.  If you needed a loan, it is common to immediately sell enough shares to cover repayment of the loan (remember: this creates a taxable event even if you have ISOs).

If you’ve got NGOs you’ll also have to come up with some way of covering the tax withholding.  Many companies allow you to do a “cashless” exercise.  In this transaction the company acquires all the shares and sells enough to cover the exercise cost and your withholding.  You get a stock certificate for whatever is left.  Some firms will also allow you to trade in shares you already own to cover the strike price.  This method creates some complicated tax situations as the transaction will have both ordinary income and capital gains imbedded in it.

I’ve used all three methods to acquire shares from exercises.  My advice?  Double check the calculations if  you’re going cashless or trading stock – I caught several mistakes made by the CFO’s office over the years.  Also, my tax withholding was never enough to cover what I owed the government.  Many years I found myself with a big tax payment due in April, so make sure to budget accordingly.

And you want me to hold the stock?

What you do with the stock once you own it can be politically tricky.

At lower levels in the company there typically aren’t expectation that you’ll hold stock indefinitely, but as you move up the corporate ladder this often changes.  Some employers track your company stock holdings, using it as an indication of your “commitment” to the company.  Sell shares and someone will likely be calling you to ask for an explanation.

One of my employers set “ownership guidelines” for senior managers.  Senior managers were strongly discouraged from selling shares until they “met” the guideline (a percentage of annual salary, and for some jobs more than 100%).  Even when the guidelines were met, senior managers were sometimes punished (by foregoing new stock option grants) if they sold stock.  In the words of one of the company’s most senior executives:  “Company stock is for widows and orphans.”

Under such expectations, you sell shares at your own (political) risk.

Holding too much stock for too long can hurt you, too

Talk to investment advisors and they will tell you that holding the bulk of your retirement savings in a single stock is crazy.  While you may feel slightly more secure if the “single stock” is your employer’s – if you have confidence in the company’s future, that is.  Eventually, common sense says, you should diversify your holdings.

Which means you’ll have to sell shares, regardless of the political implications.

Or you could just continue wait.  But I wouldn’t recommend it.  You want to sell shares based on your timing, not the company’s.  That may work out great if you plan to retire from this company some day in the distant future.  Unfortunately, sometimes the company has other plans for you – like termination or forcing you out.

Oops, I shoulda handled dis better...

I waited too long to sell stock when working for one of my employers.  In the run-up to the 2008 market crash, I realized our company’s stock was “fully valued.”  In response, I exercised all of my options in May of that year.  At the time I was feeling insecure about my future with the company, and I wanted to make sure I didn’t lose my unexercised options.  This created a large gain, and I knew there would be a rather large tax liability the next spring.

I did not however, follow my instincts and sell any of the company stock at that time.  That was a mistake.

A few months later, the market crashed and the company’s stock dropped to less than 1/3 of its prior value.  If it hadn’t been for the company’s draconian stock ownership rules, I would have sold everything near the peak.

By the time the stock price bottomed, the company fired me.  It made my May options exercise seem almost prophetic – except for the fact that I should have also sold every share I owned at that time.

As it turned out my retirement resources declined by 2/3rds.  Then to add insult to injury, when I was forced to sell shares to cover my tax liability, I had to dump them in a terrible market.  That forced me to sell many more shares than should have been the necessary.

I was patient with the remaining (decimated) shares and waited for the market to rebound, getting about 60% of the high-water value.  The proceeds were then invested in a more diversified portfolio and grew with the recovery.

If I’d been free to handle the stock sale as I wanted (free from the corporate ownership guidelines) my ending retirement account wouldn’t have declined nearly as much.


Remember that even though the company has their own policies and aims where it comes to options and stock ownership, in the end it’s your money.  Recognize the reality of how your needs may politically impact your future, but also realize you are “rolling the dice” if you allow too many of your retirement assets to be concentrated in your employer’s stock. 33.5

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This is the cover of my latest novel, PURSUING OTHER OPPORTUNITIES, released in April, 2014.  This story marks the return of LEVERAGE characters Mark Carson and Cathy Chin, now going by the name of Matt and Sandy Lively and on the run from the FBI.  The pair are working for a remote British Columbia lodge specializing in Corporate adventure/retreats for senior executives.  When the Redhouse Consulting retreat goes horribly wrong, Matt finds himself pursuing kidnappers through the wilderness, while Sandy simultaneously tries to fend off an inquisitive police detective and an aggressive lodge owner.

My novels are based on extensions of 27 years of personal experience as a senior manager in public corporations.