For many in the tech industry, especially those at early-stage companies, stock-based compensation can make up a large part of their total compensation. This commonly-held but seldom-understood type of compensation (whether it’s stock options, restricted stock, or others) can seem like an enigma, making it hard to know if it’s your ticket to financial independence or a mere distraction. And how can you really evaluate it as a part of your compensation package if you don’t really know how to value it?
Of course there are a number of factors involved in what your stock options will eventually be worth, namely being:
Timing - How early did you arrive at the company, and were you at an executive level where your deferred compensation is substantial relative to your salary and bonus?
Market acceptance – Does the company have product/market fit? How quickly is it growing? Is the company meeting financial targets?
Capital markets (IPO) – What are the markets doing? If you’re at a private company that goes public, market conditions and the general sentiment of institutional investors at IPO time will be a primary factor in determining valuation. How much capital is chasing how many opportunities?
Acquisition financing – What are the financing terms? If your firm takes the acquisition route, market conditions will dictate the terms of financing the acquiring firm uses to purchase your firm (how rich is the valuation of their own stock, or what is the cost of debt financing).
But for as much of the equity story that is out of your control, there’s a lot that’s within it, including:
Timing of exercise
Timing of disposition (i.e. sale, liquidation)
Value at disposition
Because stock-based compensation can be confusing, many people feel their financial fate is contingent upon it being a viable source of money, and yet they don’t take great care in trying to maximize the value of this hard-earned pay. This often results in people taking one of these two less-than-optimal approaches to dealing with stock-related decisions:
The “One Blind Eye” Approach
In some cases, people will focus on either the tax or the investment side of the equation, typically choosing to focus on the one side that feels most familiar, while assuming that the other half of the equation is a fixed outcome and should therefore be disregarded. In a way, this is like going to the eye doctor for a vision test, except that your eyes are looking at two different exhibits. The left eye sees a green light, and the right sees a stop sign, and then you decide which one to believe based on what you like more – essentially rendering one eye blind. Not a great approach for a complex financial decision.
Waiting for a Life Event
The other common approach is to simply sell the stock when there is a major life event, like buying a house. Investment decisions that aren’t based upon the attractiveness of the investment often result in low value returns, and ones made without consideration of taxes can result in unanticipated tax consequences. It is too common that I hear people talk about liquidating all of their stock options to fund a home purchase in hopes of avoiding the 5% interest they might pay on a mortgage, only to realize later that if they waited they could have sold their stock for considerably more than what that interest cost them.
Stock-based compensation can be complex, but it doesn’t have to be overwhelming. With a financial advisor, you can make sure to steer clear of common mistakes in order to get the most out of your hard-earned equity. You focus on moving the needle doing what you do best, and let Paceline do the rest.
To learn more please download your copy of our free E-Book: Equity-Based Compensation 101, or visit our technology professionals page to hear about how we work with clients.
This blog was written by Jeremy Bohne, Principal & Founder of Paceline Wealth Management. Paceline is a fee-only investment advisor serving clients in the Boston area, and on a remote basis throughout the country. Paceline specializes in helping tech and biotech executives, physicians, and those seeking financial planning services.