When it comes to stock-based compensation, the stereotypical image is of someone slaving away in a tech or biopharma startup, long awaiting their successful exit through either an eventual IPO, or perhaps acquisition. But the reality is that stock-based compensation is increasingly common, whether it’s at seed-stage startups or large public companies.
Regardless of what size company you work for, understanding how to manage your employer stock can be confusing. Keep reading to learn about some of the most common mistakes made by those who receive stock-based compensation, and how to keep this hard-earned pay from slipping out of your hands.
Mistake #1: Not keeping track of all your grants – As we always say here at Paceline, the most important thing is to know what you own, and why you own it. That’s why you should be sure to read and keep a copy of any stock grants you’re given. (Sounds obvious, but you’d be surprised how many people don’t do this) Even at a single employer, it’s not uncommon for one person to have a combination of restricted stock, stock options, and also participate in an employee stock purchase plan – all of which can potentially have different terms and vesting schedules.
“Get it right” tip: Not sure how to interpret all the legalese and financial jargon in your equity grant or Shareholder plan? Ask before you act – Paceline can help.
Mistake #2: Not formally accepting stock grants – Most people are surprised to know that there is often a formal process for accepting new stock grants. This is true not just for when you join a company, but also if you happen to receive new grants during the course of your employment. Typically, this involves signing a document, either in paper form or online, indicating that you agree to the terms of the stock grant/plan, which are a requirement to receive them. Just as it’s important to get details about a bonus included in a written offer letter, you need to accept your options to actually get them. If you don’t, you may end up inadvertently forfeiting them. Not a good outcome.
“Get it right” tip: If you’re not sure if you’ve signed the appropriate paperwork, be sure to check in with your finance or HR department. They should be able to provide a copy of all of your signed paperwork, and highlight if there’s anything you’re missing.
Mistake #3: Not tracking cost basis – Understanding cost basis is really important not only for stock options, but also for restricted stock. Cost basis is “the original value” of an investment, used for tax purposes (an increase in value above this amount would result in a gain, and a decrease would result in a loss).
With stock options, cost basis is the “exercise price” stated on your stock grant, which is what you would pay to purchase the shares. This tends to cause less confusion, given that the price is defined long in advance of you taking any action, and it is documented in your grant.
For restricted stock, there is much less responsibility placed upon the employee because you don’t have to decide if or when to buy your shares (when they vest, they are “gifted” to you, so they always have value). However, cost basis is typically not reported to brokerage firms where public company stock may be held. Because they don’t have this data, it is often reported as $0.00, when in fact it would have been the value of the stock upon the date it vested. If you don’t correctly report cost basis, you could end up paying taxes twice on the same stock, and nobody wants to do that.
“Get it right” tip: When restricted stock vests, it is taxed as W-2 Income and this is where you’d find this information. You can ask HR or your finance department for this information, and you’ll need it to correctly file your taxes during any year that your restricted stock vested.
Mistake #4: Not maintaining sufficient liquidity – Maintaining liquidity is relevant for all stock options, but this is especially the case when it comes to private companies. In an early stage private company, it could be years before your company sees a potential exit, and we understand the sentiment held by some that an exit is often 18-24 months away on a rolling 18-24 month basis.
Stock options give you the right, but NOT the obligation, to purchase company stock with your own money, for a specified price, within a specific window of time. This means that in order to exercise your options, you’ll be paying money that won’t see a return for a (potentially) long period of time. As a result, you need to be sure that you can part with that money until the company sees its eventual exit.
“Get it right” tip: Exercising your options is a long-term investment. If you exercise, it’s because you believe the company will be successful. People are attuned to the risks of startup failure, but it’s equally important to keep in mind that your cash investment (even if successful) may not be returned to you for several years.
Mistake #5: Forgetting that grants have expiration dates - Good things don’t last forever, and the same holds true for stock options. In the absence of corporate events (M&A, IPO, or new funding) or leaving the company, people sometimes forget that stock options have a finite term. This will be detailed in your stock grant, but is often about 10 years. Also note that you may have multiple equity grants, each with different expiration dates.
“Get it right” tip: Don’t count on your employer to remind you when equity grants expire. When accepting your grant, verify the expiration date of your options and make note for your future records.
There’s a lot to remember when you’re joining a new company, but don’t lose sight of these important details. Gathering this information upfront is expected behavior from new employees, so it could save you considerable stress when your next career move is on the horizon.
If you’re not sure how to evaluate and value, accept, or manage your equity, Paceline can help. Contact us for a free consultation.
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.