Employees of publicly traded companies tend to have the benefit of receiving employee stocks either in the form of options, restricted stock units (RSU) or through an employee stock purchase plan (ESPP). Each of those benefits can be profitable when the company has growth (think Apple right now :)) but it is also taxable.
Let’s review the different stock benefit available and then we can assess the hold or sell strategy.
Company Stock Options
Stock options are usually given as a retention benefit since they vest very slowly over time and it’s tied to the performance of the company. The way it works is that you are given the option to buy shares at a set price and the shares have an expiry date (usually 10 years from grant). The grant will usually vest over 4 years which means you will get your shares over a 4 year period and then you have another 6 years to decide whether or not you want to exercice your right buy them (which most people don’t) or sell them (which consist of buying and selling right away). The vesting pattern usually provides you with 24% after 1 year and then 2% every month after that. As you can see, it’s a slow trickle of shares which act as a retention benefit.
As an example, let’s say you receive a grant of 1,000 shares from company ABC at the price of $10. After 4 years, you would usually have been fully vested and based on the share price of ABC, you either make money or not. If the price is at $20, you make $10,000 (1,000 * ($20 – $10)). If the price is below $10, you make nothing and you simply let the options expire on their expiration date.
Restricted Stock Units (RSU)
RSU are interesting since they guarantee you to get some money but the pay off is not usually as much as the options. I have found that a company will tend to switch away from options to RSU when the options don’t provide the retention goal desired. Directors will still receive thousands of options but employees might be on a RSU plan rather than options to be guaranteed a gain when the stocks goes sideways.
Just like options, RSUs have a vesting period and from experience, you tend to get your shares annually on the first, second and third year. I have seen grants very between 1 and 4 years but you always get the fraction of shares on the annual anniversary of the grant.
As an example, you might be granted 600 shares of company ABC with a stock price of $10 on the grant date and a 3 year vesting period. The price on the grant date is sort of irrelevant here since on the first year anniversary, you will get 1/3 minus taxes :) That’s right, the tax man takes its cut. For the benefit of the employee, the company may simply cover 50% of your tax from the shares and tax the difference on your salary. If you get 200 shares and you are in a 40% tax bracket, then the company would keep 20% of the shares which is 40 shares in this case. The other 20% (equivalent of 20 shares * anniversary share price) will be tax on your pay over a number of pay period.
Employee Stock Purchase Plan (ESPP)
The employee stock purchase plan (or ESPP) allows employees to purchase shares from the company at a discount (10% to 20% below market value) through a saving plan. The saving plan tends to allow you to put X percentage of your gross pay aside until the ESPP purchase date. At every purchase, you are basically guaranteed the discounted price but that discount is also taxable as a benefit. Just like RSUs, a company tends to tax your pay for a number of pay period to cover the taxes due.
Managing Your Employee Stocks
When it comes to options, most employees will end up cashing them in so there isn’t much to manage after the fact but the big question everyone who has options is when to sell? The same goes with RSU and ESPP.
I was caught in a situation where I was making a fair bit of money with my options only to hold on too long during the financial meltdown and lose a fair amount – file that one under life lesson :(. So, when do you sell? Just like investing, you need a plan. Depending on what company you work for, you need to assess your diversification and weight your sector exposure. Most employees tend to not see their employer as an investment and personal emotion towards the company come into play. Don’t be caught having your retirement plan invested in your company – it can be quite a risk. Over time, your ESPP can really add up and my take is that you should have a sell plan to diversify.
Do the same research on your company that you would do on any other investment. If I had done that, I would probably have seen it coming. If you are not a stock investor, ask yourself if you would buy stocks in the company if you weren’t an employee. That would usually help assess if you would want such company in your portfolio.
Here are some simple questions to ask yourself:
- Would I buy this company and hold it in my portfolio?
- What percentage of my portfolio should I hold in this company?
- What’s your sell plan?
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