Things to know and ask before accepting stock options
Stock options have been a common way of offering compensation for the last few decades. Especially during the Dotcom boom in the nineties, stock options were a way to draw talented people to rising start-ups and tech companies.
Companies would offer a part of the future growth and wealth of the company to pay people slightly less money. However after the dotcom bust, a lot of these companies became insolvent and these stock options became pretty worthless.
These days you still get offered stock options but they tend to be an added bonus. So firstly, what is a stock option? Well it is the option to buy company stock. It’s a great way of keeping your employees incentivised because it helps make the employee feel more connected with the business. The employee’s hard work will usually mean more money for their stock too and will hopefully make the employee more of a company person.
Now obviously it is very important to have both the company’s goals/interests and the employees goals/interests on the same path. The company will have long term goals and want to try be keeping you around. This is where stock options are great as they are normally given with restrictions.
Here are a few questions you should ask before you accept any stock options.
1. What kind of stock options
Equity is granted in different forms, Incentive Stock Options (ISO) and Restricted Stock Units (RSU). Restricted Stock options tend to be the most popular. Dealing with tax is different for each type and can be a bit of a nuisance.
2. Is everyone on the same vesting schedule?
You earn your equity over time; you don’t just get it all on day one. This is called vesting and you’re given a set of terms before u accept the job. When you meet these terms you are given your equity. You shouldn’t work for any hiring manager who tries to tell you that you need to work for a long time before u receive any equity. To fix this any honest manager will use a vesting schedule. A standard vesting schedule will last four years and usually have a one year cliff. This means if you leave before one year of working there you will not receive your equity. Sometimes Restricted Stock Unit grants have conditions tied to them.
3. How many options will I be granted in the future?
This all will depend on your performance in the work place. Obviously someone who is putting hard work in has a better chance of receiving more stock options. Some companies offer employees with a yearly small options grant. Normally a start ups option pool varies but the average figure can be 15-20% of the company’s total Capitalization. A good employer will be able to give u an estimated guess of the company’s valuation upon an exit. If they can’t then this should be a big red flag to you! Obviously at the early stages of a start-up it will be hard to guess exact numbers but they can provide an estimate.
You should watch out for the repurchase rights. Sometimes there is a termination of stock options if you violate clauses. There also might be unusual clauses in the documents too. Some companies try maintaining the repurchase rights which basically mean you may potentially forfeit your equity when you quit or get sacked. A lot of employees don’t know this until they leave the company.
Things to note when it comes to tax, restricted stocks normally means delayed tax. These types of stock are taxed differently than other kinds. For restricted stock plans the amount of vested stock has to be counted as ordinary income in the year of vesting.
To find out how much you have to declare you have to subtract the original purchase or exercise price of the stock from the market valuation of the stock at the date it was vested.
If you don’t sell your stock during vesting and you sell it at a later time then any difference in price and the fair market value is reported as capital gain or loss.
If you need help with tax then visit The Founders Workbench