You have company stock – what does that mean?

Have you recently started a new job or been job hunting and seen “company stock” as a part of the benefits package? For many public companies, this has become a growing trend on how to attract top talent and retrain employees. Do you understand how this benefit works? Are you being offered RSUs or ISOs? What are the differences and how should you consider them when evaluating your total earnings from your employer? We’d like to help you better understand your benefit.

Stock options as part of your compensation

As an employee putting in hard work and sweat for your employer, it’s nice to reap the benefits of your efforts when the company is thriving. Employers can share their success with employees through promotions, raises, bonuses and profit sharing. Generally profit sharing looks like employees getting some form of equity in the company – ownership! There are a few different ways employers can offer or grant ownership to their dedicated hardworking employees.

Sign on bonuses and annual performance bonuses for many public companies are being offered in the form of company stock. This is a nice bump to an employees total earnings – and a way to keep them locked in to the firm. Most of these stock offerings come with a vesting period. This means that they are not available to you on day one. You have to wait till some future date when they will “vest”. Then you can exercise or sell your options/shares.

If you don’t plan to stay with your employer very long, then you may be giving up a lot of future income. When you leave your employer and you have shares or stock options that have NOT vested, you lose them. They become worthless!

So before you quit in an angry fit of rage or jump at the next best job offer, be sure to consider what you’re giving up. Calculate the value of the shares or options that will expire worthless and use that to bargain with your new employer. Ask for either a sign on bonus worth the amount you’re giving up in cash OR shares of your new employer. Or delay your start date until after your shares have vested.

There are different kinds of stock grants. Let’s dive into the differences and which you may prefer.

What are Restricted Stock Units (RSUs)?

RSUs represent a promise to grant (i.e. gift) employees actual shares of the company’s stock after vesting, without any upfront cost. These are the easiest stock grants to understand from a vesting and tax perspective. They require NO purchase or cash from the employees. Think of them as a gift you have to wait to open for a few months or longer. Just like you don’t know what’s in a wrapped gift – you don’t know the final “worth” of your RSUs until their vesting date.

Let’s look at an example:

Suzy starts her new job on 4/1/2024 and is granted a sign-on bonus of 1,000 RSUs. They will vest evenly over the next 4 quarters. That means she will have access to 250 shares of stock on 7/1/2024 and then 250 more shares for 3 more quarters. Suzy won’t know how much her final “take home” value of the 1,000 RSUs will be until after the final 250 shares have vested on 4/1/2025.

How do you know how much your RSUs are worth? Look at today’s share price of your company and use that as a proxy for how much you MAY get for all your shares. This number will not be accurate but it may be close, plus or minus about 10 to 15% in either direction if your company doesn’t see a lot of volatility.

Pros of RSUs

• Easy to understand
• Immediate ownership without upfront costs or the need to exercise
• Receive company shares upon vesting
• Taxes are straightforward
  • Pay ordinary income tax when they vest on the total vested value
  • Pay capital gains (short or long) tax when shares are sold if sold at a gain
• RSUs have value as long as the company stock is above $0

Cons of RSUs

• Taxed as ordinary income upon vesting
• Employer must withhold taxes when shares vest
• No ability to control the timing of your taxes
• Any shares not vested are worthless upon termination

What are Incentive Stock Options (ISOs)?

ISOs give employees the right to purchase shares at a predetermined price (exercise price) after vesting. Instead of an outright gift like RSUs, employees must actively exercise (purchase) the options to acquire the shares when their ISOs vest.

Let’s look at another example:

Jeff starts a new job on 4/1/2024 and receives 1,000 ISOs. His ISOs have an exercise price of $20 per share and will vest evenly over the next four quarters. That means on 7/1/2024 he will have 250 options vest and will have the ability to exercise these options for $20 per share. If the stock price on 7/1/2025 is HIGHER than $20 – say they are $30 per share – then he’ll want to exercise his options. He would be getting a $10 discount! There is only one small hiccup. In order to turn his 250 options into 250 shares, he will need to have $5,000 to buy them. Due to this feature of ISOs, they may not be as desirable. Not all employees will be able to afford to exercise their options.

Another risk with ISOs is that the value of the stock may be LOWER than the exercise price when the options vest. Instead of being $30 per share on 7/1/2025, what if the stock price was $15 per share? Then the options would be “out of the money”. Who would pay $20 per option to buy shares when they could buy them on the stock market for $15 per share?

Pros of ISOs

• Can offer higher potential upside (than RSUs) if the company’s stock performs well
• No taxes are due when options are granted or exercised (except for potential Alternative Minimum Tax (AMT))
• Employers do not have to withhold payroll taxes when employees exercise ISOs
• When selling exercised shares, any gain is taxed as capital gains if certain holding period requirements are met. Otherwise, it’s taxed as ordinary income

Cons of ISOs

• Employees need their own cash to exercise options, to get company shares
• Tax treatment is more complicated
  • Certain holding periods required to pay lower taxes
  • Must keep track of EACH vested portion and the dates upon when they are exercised, for tax treatment
  • Exercising ISOs can trigger AMT tax if the spread between the exercise price and fair market value exceeds certain limits.
• Stock options only have value if the stock price exceeds the exercise price at the time of exercise
• You only have 90 days to exercise vested ISOs when you leave your employer or they expire worthless

Know your Options

If you are fortunate to have company stock or options as a part of your employee benefits – know what you have. Read through the offer documents to understand the terms. When considering a job change or promotion, factor in your RSUs or ISOs to your asking price.

While RSUs and ISOs are very different and each has its drawbacks, they are both very valuable. If you have questions about your own company stock options or want a second opinion on what to do with them, schedule a meeting with us.

At CAM we have clients with varying types of company stock. Some clients hold company stock from many of the big headline public companies, while others hold shares of private companies. Whatever your situation is, let us help you navigate the options world.

Disclosure

M & A Consulting Group, LLC, doing business as CAM Investor Solutions is an SEC registered investment adviser. As a fee-only firm, we do not receive commissions nor sell any insurance products. We provide financial planning and investment information that we believe to be useful and accurate. However, there cannot be any guarantees. 

This blog has been provided solely for informational purposes and does not represent investment advice. Nor does it provide an opinion regarding fairness of any transaction. It does not constitute an offer, solicitation or a recommendation to buy or sell any particular security or instrument or to adopt any investment strategy.

Past performance is not a guarantee of future results. Diversification does not eliminate the risk of market loss. Tax planning and investment illustrations are provided for educational purposes and should not be considered tax advice or recommendations. Investors should seek additional advice from their financial advisor or tax professional.