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Guide to Employee Equity Compensation

October 16, 2018 | Personal Capital

If you have the opportunity, sharing in the upside of your company’s growth through equity of the company can be a good idea for your long-term financial goals.

Given the rise in popularity of equity as a form of employee compensation – and thus, as a potential portion of your wealth – it’s important to know the basics of popular forms of equity compensation.

The Personal Capital Guide to Employee Equity Compensation will provide high-level education on this form of compensation, and how it fits into your tax strategy, overall net worth, and long-term financial plans.

Equity compensation can be quite complex – but with the right knowledge and a clear strategy in place, you may be able to leverage yours within your comprehensive financial plan to meet your goals even sooner.

Download This Guide as a PDF

What Is Employee Equity Compensation?

Employee equity compensation is a form of non-cash compensation that confers partial ownership in your company, i.e., non-cash compensation.

Both private and public companies have offered equity compensation for myriad reasons. One of the more common reasons is that offering non-cash compensation allows companies to prioritize cash flows to continue to grow the company or for other initiatives; another benefit is that it can be used to lure quality employees to work for them and to keep those talented individuals employed and motivated.

There are different forms of equity compensation, each with unique characteristics, benefits, challenges, and – importantly – varying tax ramifications. It’s important to remember these will impact your overall net worth and financial outlooks, so you’ll want to carefully think through your strategy regarding your equity compensation.

The Personal Capital Guide to Employee Equity Compensation will provide high-level education on this form of compensation, and how it fits into your tax strategy, overall net worth, and long-term financial plans.

Equity compensation can be quite complex – but with the right knowledge and a clear strategy in place, you may be able to leverage yours within your comprehensive financial plan to meet your goals even sooner.

Knowledge Check: Can You Define These Terms?

Employee Compensation Restrictions

Employers often include time or performance-based restrictions as part of employee compensation packages.

These restrictions are meant to encourage employee retention and align incentives between the employee and the firm. When these criteria are met, the option will vest and the stock becomes available for exercise and ownership. These restrictions generally apply to restricted stock and stock options (since participation in employee stock purchase plans are usually up to the employee’s discretion whether to participate).

Time Restrictions

Sometimes called “service restrictions,” this restriction relates to the length of time you are with the company.

A “typical” time restriction might say that your options vest monthly over four years with a one-year “cliff.” This means no vesting occurs on your options for your first year. After your first anniversary date, 25% of your grant vests and the remaining portion will vest monthly for the remaining three years.

Performance Restrictions

This type of restriction bases your access to equity on your achievement of pre-set goals, whether it’s company performance (such as revenue growth or margin improvement) or individual performance (such as development milestones).

Market events can also impact performance restrictions. For example, in the event of an IPO, the performance date is set for a specified amount of time after the IPO. The extra buffer is called a “lock-up,” and prevents employees from flooding the market with stock sales. This type of restrictions isn’t necessarily applicable to all compensation types; ESPPs, for example, usually allow all employees to participate without it being dependent on their performance.

Transferability Restrictions

Before your shares vest, you generally cannot transfer options, except in very limited situations.

This generally applies to all types of employee equity compensation since the ability to exercise and subsequently sell the stock is dependent on whether you have earned/received it and the award has vested.

Main Types Of Equity Compensation

There are generally three types of equity compensation awarded to employees: stock options, Employee Stock Purchase Plans (ESPPs) and restricted stock.

These can be further broken down. Stock options generally can be categorized as either Incentive Stock Options (ISOs) or Nonstatutory Stock Options (NSOs), which are commonly known as Non-Qualified Stock Options (NQOs). On the other hand, restricted stock (in the context of equity compensation) begins its life as either Restricted Stock Units (RSUs) or Restricted Stock Awards (RSAs).

Each type of compensation has unique characteristics, so it’s important to identify what your equity compensation is so you can understand its benefits and potential challenges.

There are a lot of different terms and definitions around equity compensation, which can get confusing – especially because there are different names for essentially the same things. Open the drop-down menu for a glossary of some of the most common terms you should know. Keep in mind, these are high-level definitions, and their exact meaning may change depending on what type of compensation they’re applied to.

Key Terms and Definitions
  • Stock option – A formal, written offer for a company to sell (and for you to purchase) stock at a specified price, subject to time limits and conditions specified in the option agreement.
  • Restricted Stock Unit/Award (RSU/RSA) – Equity compensation offered to an employee by way of an agreement in which you’ll receive shares of stock (for cash payment, in the case of some RSAs) on a future date.  The unit/award should not be confused with “restricted stock.”
  • Bargain Element – Also known as  the “spread,” this refers to the “discount” for the purchase of stock at a price that is lower than the Fair Market Value (FMV) on the purchase date; essentially, this is the difference between FMV of the stock at the time of grant and its exercise price.
  • Fair Market Value (FMV) – The price at which the stock is currently trading (private companies may calculate this in slightly different ways compared to companies that are publicly traded).
  • Grant date – The date that your units, shares, or options are offered to you by your employer.
  • Vesting date – The date (or dates) on which restrictions lapse and the stock becomes available for transfer to you.
  • Vesting (vesting schedule) – The schedule dictating when you may exercise your stock options or when forfeiture restrictions lapse for restricted stock. Vesting is typically a time-based “waiting period,” which you have to complete before you can exercise options. Vesting is determined separately for each grant.
  • Exercise – When you notify the company you want to purchase the stock and provide payment per the terms of your agreement.
  • Exercise date – The date on which you have the option (but not obligation) to buy or sell the security instrument at a specified price.
  • Exercise price/strike price – The pre-set price at which you are able to exercise your right to purchase shares of company stock (typically FMV on the date of the grant).
  • Sale date – The date when you legally dispose of the stock that was acquired, whether it’s by sale, gift or other transfer (as allowed by the plan).
  • Disqualifying disposition – The legal term for selling, transferring, or exchanging shares before satisfying the holding period requirements; i.e., two years from date of grant and one year from date of exercise. If you sell, transfer, gift or short the stock too soon, you lose the tax benefits.

I. Stock Options

Stock options are probably the most well-known form of equity compensation.

A stock option is the right to buy a specific number of shares of company stock at a pre-set price, known as the “exercise” or “strike price,” for a fixed period of time, usually following a predetermined waiting period, called the “vesting period.” Most vesting periods span follow three to five years, with a certain percentage of options vesting (which means you’ve “earned” your shares, though you still need to exercise (i.e., purchase them).

When it comes to options, one of their biggest advantages is leverage. With more options per grant relative to other forms of equity compensation, there is significant upside potential But despite the upside, these don’t come without risk.

The Appeal of Stock Options

Stock options are commonly used to attract prospective employees and to retain current employees.

The incentive of stock options to a prospective employee is the possibility of owning stock of the company at a discounted rate compared to buying the stock on the open market.

The retention of employees who have been granted stock options occurs through a technique called vesting. Vesting helps employers encourage employees to stay through the vesting period to obtain the shares granted to them. Your options don’t belong to you until you have met the requirements of the vesting schedule.

For example, assume you have been granted 10,000 shares with a four-year vesting schedule at 2,500 shares at the end of each year. This means you have to stay for at least one full year in order to exercise the first 2,500 shares and must stay to the end of the fourth year to be able to exercise all 10,000 shares. In order to receive your full grant, you will likely have to stay with your company the full vesting period.

When You Can Exercise

First and foremost, you cannot exercise your options until they are vested.

There may be some agreements that can accelerate the vesting schedule (e.g., in the event of an acquisition), but these are rare. And there are also time limits on when you can exercise or access your options – they typically expire after 10 years from the date of grant. In addition, if you are laid off before you are vested in your options or your company is acquired by another company, you may lose your unvested options. See each section for ISOs and NSOs on some possible exercising strategies.

How You Can Exercise

Once you are ready to exercise your options, you typically have several ways of doing so:

  1. Cash Payment You can come up with the cash to exercise the options. This would include covering any costs to acquire the stock.
  2. Cashless Exercise Some employers allow you to exercise your options and your employer sells just enough of the stock to cover the costs you incurred to acquire the stock.
  3. You can sell all the shares you exercise at the going market price, which means you won’t have any ongoing exposure to any stock price volatility and you won’t have to come up with the upfront cash for any transaction costs when you exercise. However, the tax implications may not be beneficial, depending on your unique situation.

Incentive Stock Options (ISOs)

What are ISOs?

Incentive stock options (ISOs) – also referred to as Qualified Stock Options – can be granted only to employees of a company (independent contractors are not permitted).

While many people get excited about options and what their value might mean for their financial futures, it’s good to remember there are certain strategies you can either implement or avoid to ensure you are getting the outcome you want.

ISO Tax Treatment

ISOs potentially have more favorable tax treatment than many other types of employee equity compensation.

This is because they are not taxed for regular tax purposes until they are sold. However, to qualify for the treatment as capital gains tax on a standard tax return, you must hold the shares two years from grant and one year from exercise (if you don’t meet this requirement, then the sale will be treated as a disqualifying disposition). If these dates are met and the value of the stock increases, you’ll only owe long-term capital gains tax when you sell.

While ISOs are not taxed for regular tax purposes until they are sold (if you meet the holding requirements), the alternative minimum tax (AMT) may be applicable at time of exercise. If you pay AMT upon exercise of the options, you may be entitled to an AMT tax credit that can be used to lower your income tax bill in subsequent tax years when the amount you owe is more than it would have been under the AMT.

Note that the bargain element (again, the difference between the grant price and the exercise price) is considered an AMT preference in the year that you exercise your ISOs. In order to determine if you are subject to AMT, you have to complete your regular IRS Form 1040 and Form 6251 to determine if you are subject to AMT. You’ll owe taxes on the greater of your regular tax or the tax determined under the AMT calculations.

Exercising ISOs

ISOs can be a bit trickier to exercise than NSOs because tax consequences depend on how long you hold the shares.

If you hold on to your shares for the qualification period (two years after grant, one year after exercise) and things go well, then the stock will go up in value, and as mentioned before, you will likely only owe long-term capital gains rates when you sell. You may, however, still need to put up a sizable amount of cash upon exercise (depending on the strike price). And it’s possible your stock’s value could just as easily go the other way, which means you would erase any potential gains – and in some cases, may have to pay out of pocket to cover taxes. Talk to your financial advisor or tax expert to learn more.

Nonstatutory Stock Options

What are NSOs?

Nonstatutory Stock Options (NSOs) are also known as Non-Qualified Stock Options (NQOs).

They are typically used by more mature companies for higher-paid employees (as well as contractors, consultants and other non-employees, if companies want to give them more than $100,000 worth annually). Because NSOs do not meet the requirements of IRS Code Section 422, they do not benefit from the (potential) corresponding tax benefits that ISOs do.

NSO Tax Treatment

Typically, NSOs are taxed at the date of exercise rather than the date of grant.

The amount subject to ordinary income tax is the difference between the fair market value at the time of exercise and the exercise price. If you continue to hold the stock after exercise, any gain in price is subject to capital gains rules (long-term, if you hold for more than 12 months).

For example, let’s say you are granted 300 shares of XYZ, Inc., on January 1, 2016, with an exercise price of $10 per share, with 100 shares vesting each year for the next three years. After the first year, you exercise 100 vested shares when the FMV is $30. The amount reported as ordinary income is $2,000 – (i.e., [$30 FMV – $10 exercise] x 100 shares). Let’s say you hold the stock for one more year and sell when the FMV is $42. The amount subject to capital gains tax then is $1,200 (i.e., [$42 FMV – $30] x 100 shares).

NSOs are subject to ordinary income tax and reported as W-2 wages for employees. They are also subject to federal and state income taxes, as well as Social Security and Medicare taxes.

Diversifying After Exercising NSOs

Since NSOs are taxed as ordinary income upon exercise, we generally recommend diversifying right away if you are deep in the money and there is no special reason to defer income (vs. holding and hoping the stock goes up).

If you exercised shares in the past and now hold a material amount of stock, then it can often make sense to start diversifying. It’s usually good to start with the highest-cost, long-term lots first. The amount to sell will likely come down to how much you’re comfortable with. You should consult a tax advisor and a financial professional to learn more.

PERSONAL CAPITAL STRATEGY: SOME TAX IMPLICATIONS

The tax rules that apply to stock options are complex, so here are some very high-level, general rules of thumb:

  • If you wait to hit certain milestones, your tax treatment may be better. You could receive favorable tax treatment if you wait for two years from grant date and one year from date of exercise to sell your shares. Once these two milestones are met, any profit you generate from the sale of your stock will be taxed as long-term capital gains. (Note: this holding period is only applicable to ISOs, and you could be subject to taxation when you exercise the share.)
  • Exercising or selling before milestones can mean ordinary income treatment. If you sell or dispose of the stock within a year of exercising (or after more than a year, but less than two years from grant date), the gains will be subject to ordinary income tax treatment, rather than the often lower-tax long-term capital gain treatment. However, there may be scenarios in which disposing of the shares before meeting the milestones may be advantageous.  

Keep in mind that these are very high-level guidelines; since every situation is unique, you should check with a professional to see if these apply to you.

II. Restricted Stock

Restricted stock (which may also be known as “letter stock” or “restricted securities”) is company stock that cannot be fully transferable until certain restrictions have been met.

These can be performance or timing restrictions, similar to restrictions for options. You can think of restricted stock as a bonus awarded as stock instead of cash; however, like cash, it is taxed as if it was paid in cash (i.e., as ordinary income).

Restricted stock can be a popular alternative to stock options, particularly for executives, due to their favorable accounting rules and income tax treatment. There are two basic types of restricted stock: Restricted Stock Awards (RSAs) and Restricted Stock Units (RSUs).

Restricted Stock Awards (RSAs)

What are RSAs?

Restricted Stock Awards (RSAs) are grants of company stock that are issued to employees as rights to shares of stock that are restricted (i.e., cannot be transferred) until the shares vest, which is usually time-based, performance-based, or a combination.

Typically, companies issue shares that are held in escrow and are released upon vesting. RSAs come with immediate voting rights because you actually own the stock the moment the award is granted.

RSA Tax Treatment

Unlike stock options, restricted stock is taxed as ordinary income on the difference between FMV on the date of vesting and the amount (if any) you paid for it.

If you’re an employee, your employer will withhold federal and state income taxes as well as other payroll taxes for you. As a holder of vested stock, you are also taxed on the gains when you sell the stock.

Restricted Stock Units (RSUs)

What are RSUs?

Like RSAs, Restricted Stock Units (RSUs) represent an employer’s promise to grant the difference in price (stock price minus strike price) to employees based on vesting requirements, performance benchmarks and/or transferability restrictions.

The key difference is that RSUs are issued in the form of units – not stock – that correspond in number and value to a specified number of shares of employer stock. Upon vesting, you’ll get your equivalent shares. The result of this difference is that you are not deemed to be the holder of the shares until vesting and do not have voting rights (unlike with RSAs). This makes it a particularly popular mechanism for pre-IPO companies: RSU holders are not technically shareholders and increasing ownership does not trigger SEC filing rules.

RSU Tax Treatment

RSUs can be awarded on regular vesting schedules or performance benchmarks, which means that the value of the RSUs on the day of vesting is subject to payroll and ordinary income taxation.

Similar to the concept of a cashless exercise, some employers allow stock to be withheld to cover the statutory minimum for taxes in the form of shares, since RSUs are taxed on vesting. This provides for a net stock amount to the employee, adjusted for taxes, upon vesting. The disposition method is not restricted after vesting, unless the company is subject to “open window” trading policies.

Purchase Strategies – Restricted Stock

When you’re offered equity by your company, you need to decide how you exercise the shares. But note, if the grant is restricted stock with par value, accepting the grant means you’ll eventually be required to pay for those options when they vest.

There are typically three standard methods that you can choose within 30 days of the settlement date (the date and time that your transfer of shares is made, which establishes the legal transfer of ownership).

Three Standard Purchasing Methods
  1. Pay cash – You receive all your shares and cover your income tax burden with your own cash. So, if you believe your company’s share price is going up, this might be an attractive strategy; however, it’s riskier as you end up with equity and will deplete your cash reserves to cover the income tax burden.
  2. Cashless: Exercise and sell to cover – You receive only the portion of shares after covering the cost of your income taxes with shares. For example, if you were entitled to 100,000 shares and pay a 35% marginal tax rate, you’d get 65,000 shares. Because market price doesn’t impact your tax rate, this is likely the least risky strategy.
  3. Cashless: Exercise and sell – You sell your shares immediately and cover the purchase price, commissions, fees, and taxes. This is like paying cash, since you assume the risk of the share price (for the period of time before you sell), but it may make sense because you don’t have to raise the cash to pay your tax obligations.

Make sure to talk to your employer to see what options are available to you.

III. Employee Stock Purchase Plans (ESPPs)

An Employee Stock Purchase Plan (ESPP) is a plan in which employees are offered the ability to purchase shares of the company at a discount (commonly 15% of FMV).

ESPP plans are limited to a maximum of $25,000 worth of stock, per year, per employee. Shares/units are typically purchased via payroll deductions. Usually, at designated points during the year, your employer then uses the accumulated funds to purchase stock for you.

ESPP Tax Treatment

You must hold the position for more than two years from the beginning of the offering period, including more than one year from the date you purchased the shares.

If these criteria are met, then the sale is considered “qualified.” On the other hand, if the sale occurs before the two- and one-year periods, then it is considered “disqualified.”

Case Study: ESPPs and Taxes

Melvin has an ESPP with his company, XYZ, Inc., and he is in the 32% regular income tax bracket and the 15% long-term capital gains tax bracket.

Here are three different scenarios that impact Melvin tax-wise when he sells, depending on qualifying and disqualifying dispositions.

Scenario 1: Qualifying Disposition

Melvin holds the position for more than two years, from the beginning of the offering period, including more than one year from the date he purchased.

  • The offer period was from January 1, 2016, to June 30, 2016.
  • The price for XYZ, Inc., on January 1, 2016, was $100.
  • The price for XYZ, Inc., on June 30, 2016, was $125.
  • Melvin purchased on July 1, 2016, at a 15% discount to the January 1, 2016 price of $100, which means he had a purchase price of $85 ($100 x [100% – 15%]).
  • Melvin sold on February 24, 2018, for $130 – his $15 discount is taxed as ordinary income and the remaining $30 gain is taxed as long-term capital gains.
  • Melvin’s tax upon selling is ($15 x 0.32) + ($30 x 0.15) = $9.30.
  • Note: The bargain element of $15 should be included as ordinary income.

Scenario 2: Disqualifying Disposition, but Held Long-Term

Assume that everything from Scenario 1 is still true, except Melvin holds the position for less than two years from the beginning of the offering period. His sale is then considered “disqualified,” but he still realizes the long-term capital gains tax rate on his sale.

  • Melvin sells XYZ, Inc., on December 15, 2017 – less than two years from the offer period – when it sells for $130.
  • Melvin then owes ordinary income tax on the discount of July 1, 2016 ($125 – $85 = $40).
  • Melvin’s tax upon selling is ($40 x 0.32) + ($5 x 0.15) = $13.55.
  • Note: Typically under a disqualifying disposition, your employer will include the bargain element as part of W-2 wages.

Scenario 3: Disqualifying Disposition and Held Short-Term

Finally, imagine the same scenario but Melvin sold XYZ, Inc., for $130 on June 15, 2017. His sale is therefore considered disqualified, and his full gain is taxed as short-term gains (i.e., ordinary income)

  • Melvin’s tax upon selling is ($40 x 0.32) + ($5 x 0.32) = $14.40

This story is fictional and does not depict any actual person or event.

General Recommended Exercising & Selling Strategies

Here are some guidelines that can give you a frame of reference.

However, given the array of equity compensation structures out there with varied terms and tax consequences, it’s best to consult a professional for your unique situation.

Options

Because the effective value of your options is the market price less the exercise price, small changes in market price are amplified in your effective value, which boosts your options’ inherent investment leverage.

In other words, the same absolute price movement is higher on a percentage basis for your “equity.”

On the other hand, just as gains are magnified, so are losses. Options have little value unless the market value is greater than the exercise price, which creates a bit more risk than other forms of equity. If you exercise your options and the price decreases, then you lose both the money you’ve used to exercise the shares as well as any associated taxes.

  • ISOs – These can be a little tricky – they can be treated as NSOs in certain circumstances, or you can try to hold onto them until they become long-term for preferential tax treatment, which comes with more risk
  • NSOs – There’s no hard-and-fast rule here, but it’s generally a good idea to have more aggressive diversification if they are deep in the money (~33%-plus) and there is no special reason to defer income. Do not let in-the-money options expire.
RSUs/RSAs

These types of equity compensation are taxed at the time they are vested.

In essence, you have purchased your company’s stock at the current market price. This means you should make the decision to sell them based on the stock price at the time of vesting and how large your investment is in your company’s stock. Holding your vested shares instead of selling them is similar to purchasing your company stock with your bonus check – unless you have a strong reason for keeping your company’s stock, it’s generally recommended that you sell as soon as your shares vest.

ESPPs

If shares are purchased at a meaningful discount (~10%-plus), then it’s generally recommended you participate as much as you can afford.

Then, if allowed, sell as soon as you purchase for reasons similar to those mentioned for RSUs/RSAs.

Additional Considerations

There are additional considerations when it comes to your equity awards. Some of these include:

 

  • Concentrated positions – A position is usually considered “concentrated” when it makes up more than 5% to 6% of your liquid net worth. If the vested/sellable portion of your equity awards exceeds this amount, there is normally an increased urgency to pare down (see the following section on Employee Equity Compensation & Your Portfolio)
  • Private company – If you have stock options for a private company, you likely will want to be very cautious about exercising your shares since you may not be able to sell until/unless there is a liquidity event
  • Tax bracket – Depending on the circumstances, it may make sense to defer a portion of sales until the following year if realizing gains will raise either your federal income or long-term gains tax bracket. Or, if diversifying your portfolio is more of a concern and your tax bracket won’t change from year to year, it might make sense just to incur the tax hit so that your overall concentration makes sense.  

PERSONAL CAPITAL STRATEGY: A FEW TIPS ON EXERCISING

As we’ve mentioned before, employee equity compensation is complex and unique to your own individual situation. How you exercise will depend on many different variables; however, here are a few additional tips to consider when exercising:

  1. Consider exercising early with cash if it makes sense. It starts the clock early on capital gains. The main risk, however, is the loss or opportunity cost of the capital that you use. If you’re leaving your job, then you may be forced to go this route.
  2. Think about whether you may benefit from a cashless exercise if your shares are liquid or if your company will buy them back. This way, you don’t have to raise cash, and you’ll be hedging by taking some of your shares off the table if the share price goes down. Sure, you may pay more tax, but you’re not putting your existing capital at risk.
  3. If you’re concerned about the volatility of the stock, then don’t wait. Exercise and sell right away. You’re stuck paying ordinary income tax by exercising and selling at the same time, but this might be a better alternative than stomaching any volatility. If the share price decreases, then you won’t have to concern yourself with AMT, although you might have missed out on some gains, too.

To learn more, talk to a financial advisor.

Employee Equity Compensation & Your Portfolio

Many people think that equity compensation is automatically equal to a windfall – the next Facebook or Instagram story.

But the truth is, this is usually not the case for the majority of us. Equity can be a great form of compensation, since it aligns incentives between employees and employers and enables employees to build long-term wealth. However, while equity compensation may provide you more upside, beware: it can create complications relative to cash compensation. That’s why it is so important to understand how much stock is in your portfolio and how that plays into your overall net worth and future financial plans.

Equity compensation is applicable in both the startup and corporate worlds. But the scenarios are not all equal, and not all recipients find themselves on a path to riches, contrary to popular perception. The extent to which you will benefit from an equity compensation package depends on not only upon the performance of the stock, but also on how well you manage key decisions relating to your equity. In particular, understanding the type of equity you have and the associated tax implications is critical to your success – as is understanding the risk of investing in an individual stock versus a diversified portfolio.

Managing Exposure

It’s not uncommon for company stock to dominate an individual portfolio. This trend is pronounced in areas like Silicon Valley, where capital-hungry companies defer cash compensation to their hard-working employees by promising a share of future growth via equity.

When you are armed with an understanding of your current financial standing and where you want to be, you can design a game plan for managing your company stock as part of your wealth management strategy.

One big question is: how much of your company stock is it appropriate for you to own? There’s no exact answer – all of our financial pictures are different, and you can’t predict how that stock will perform. For instance, consider that the volatility of a single stock is high – according to Morningstar, the average difference between the yearly high and low of stock prices of a typical NYSE stock is 40%.

PERSONAL CAPITAL STRATEGY: UNDERSTANDING THE VALUE

When you are starting a new job and equity compensation is part of your package, there are some good questions to ask your hiring manager or a member of HR to help you get a handle on what they might be worth. Then you can negotiate other terms based on that knowledge. Some good starting questions include:

  • What type of equity compensation are you offering? Each kind comes with its own restrictions and tax ramifications, all of which impact what they could ultimately be worth to you.
  • What is the current valuation of the company? Sometimes the calculations can be skewed, or companies are not able to give that information (although, lack of transparency can also be a red flag), but it’s good to at least have a starting point.
  • How many outstanding shares are there? This directly impacts the value of your equity. After all, 1,000 shares might sound good on paper, but if there are 3,000,000 shares, then that doesn’t necessarily equal a huge value to you.  
  • What type of equity am I getting? There are many different types, all with different restrictions and consequences.
  • What do the stock documents say? Reading the fine print takes time, patience, and understanding, but it’s crucial to knowing the ultimate worth of what you’re being offered.

The more information you’re armed with, the better you can understand what your equity compensation could ultimately be worth.  Speak with a financial advisor to learn more.

Our Take

When it comes to employee equity compensation, you’re oftentimes putting yourself into a speculative position.

Sure, you have the chance of potentially coming into a big windfall, but keep in mind that you’re also placing a bet that the employer who signs your paycheck is going to be successful.

The risk comes if – like many working Americans – most of your net worth is tied up into this. That’s why it’s important to understand what awards you have, what the vesting schedule is in your situation, and what tax consequences you might have so you aren’t unnecessarily overpaying, while also managing concentration risk within your overall allocation. Also, you should understand that while taxes are an important aspect to consider, they should not be the underlying reason a diversification strategy isn’t implemented.

Rather than let your employer stock dominate your portfolio, part of managing your wealth is figuring out how to sell down some of your shares to build a diversified portfolio across the major global asset classes that’s appropriate for your risk tolerance and helps you maximize your return.

Contact a Financial Advisor

*Disclosure: This report is distributed for informational purposes only, is proprietary and confidential to Personal Capital. Any reference to the advisory services refers to Personal Capital Advisors Corporation. Personal Capital Advisors Corporation is an investment adviser registered with the Securities and Exchange Commission (SEC). Registration does not imply a certain level of skill or training nor does it imply endorsement by the company. Past performance is no guarantee of future results. It’s not possible to invest directly in an index or strategy without incurring fees and expenses. All investments involve risk of loss. This report is not, and should not be regarded as investment advice or as a recommendation regarding any particular investment strategy or course of action. All tax insight provided represents a courtesy extended to you for educational purpose, and you should not rely on this information as the primary basis of your tax planning decisions. We are not tax professionals. You should consult a qualified legal or tax professional, such as a tax attorney or CPA, regarding your specific situation.

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