What Are the Advantages of Employee Stock Options?
During the heyday of the Internet in the late 1990s, stock options were the major draw for employees of up-and-coming high-tech startups. By offering a part of the future growth and a percentage of the great wealth the company would generate rather than a higher salary, newly emerging companies were able to hold on to their cash to spend wisely. Unfortunately, many of these startups did not do so, and the companies foundered. This left many young tech executives holding worthless stock options.
Today, stock options are still part of the packages offered by many companies. However, they are typically added perks and do not serve as a replacement for a competitive salary. In addition, they are not as commonly offered by young, emerging companies.
The stock option gives you, as an employee, the opportunity to buy a specified number of shares in a company for a certain number of years. The offering price, called the grant price, is typically the market price at the time the option is offered. The benefit is that the employee can exercise the option when he or she wants to within a set period of time. If the stock has gone up, he or she can purchase the shares at the original grant price and then either sell them for a profit or hold on to the shares in hope the stock will continue to gain.
By way of an example, a typical stock option grants:
- 10,000 shares
- Exercisable at 50 cents per share
- Vesting over a 4-year period
- Exercisable until a designated date
There are two types of stock options: incentive (or qualified) stock options and non-qualified stock options. The differences primarily relate to taxes and transferability.
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Advantages of stock options
- Stock options offer employees an opportunity to have ownership in the company they work for and feel more "connected" to the business.
- Employees can reap some of the financial benefits of a successful business. This can result in employees making far more money above and beyond their annual salaries.
- They can serve as a means of starting a savings plan.
- They can serve as a financially rewarding investment for someone with a long-term financial strategy.
- They can offer some tax benefits.
An incentive stock option (ISO) lets employees avoid paying taxes on the stock they own until the shares are sold. In addition, if the employee holds the stock at least two years after receiving the option grant and more than one year after exercising the option, he or she will qualify for the long-term capital gains tax of 20%.
Non-qualified stock options may be transferred to children if the employer is amenable with such a transfer. (ISOs are not transferable except through a will). Employee stock options are a way to purchase stocks at a lower price and sell them as soon as the stock is making money. However, the bottom line will be whether or not the company looks like one that will be profitable in the future. Stock options in a company that is doing poorly are—for the time being—essentially worthless.
Therefore, look at the future plans of the company and consider how long you plan on working there before determining the potential personal advantage of having stock options.
RELATED: How Employee Stock Options Work in Startup Companies
