Some employees find themselves in the fortunate position of owning shares in the company they work for. Whether you got in on the game at ground level or joined the company during their growth, you may hold shares of significant value.
We work with a lot of clients working in quite young companies that are scaling, predominantly in the tech sector. These employees have been rewarded with shares in the business as part of their remuneration package.
Companies can reward staff with actual shares or issue options they can exercise at some defined point in the future.
The difference between shares and options
Shares and options have different uses and benefits, including the way they are treated for tax. So, it’s useful to understand the crucial differences between them.
There are two main types of shares a company may issue: ordinary shares and growth shares.
Ordinary shares give you a real share in the business and can be given to anyone. Business owners and investors usually hold this type of share.
Growth shares are the same as ordinary shares but are issued at a “hurdle price”. This price represents a small premium to the value of the company at that time (generally between 10% – 40% to reflect the “hope value” of the shares). In effect, holding these shares means you only get a share of the business growth in value from that point.
Meanwhile, stock options give you the right to buy or exercise a set number of shares of the company stock at a pre-set price. However, this offer doesn’t last forever. You have a set amount of time to exercise your options before they expire. Your employer might also require that you exercise your options within a defined period if you leave the company.
Business owners can grant options to anyone, but they are not real shares until exercised. Options don’t allow you to benefit in the same way as being a shareholder, so you won’t get dividends or voting rights until you exercise your options.
Stock option terminology: a word about “vesting” and “cliffs”
Vesting is the process of gaining full legal rights to something. Typically, founders, executives, and employees gain rights to their access their equity incrementally over time. This may be subject to restrictions.
Stock, stock options, and RSUs are almost always subject to a vesting schedule.
Most often, vesting will happen over time, according to a specific vesting schedule. You can only vest when you’re working for the company whose stock you own.
If you quit or your contract is terminated, you may lose any equity you thought you had. If, on the other hand, you stick with the company for years, you’ll get most or all of what you were expecting.
Vesting schedules may have a built-in cliff. This is a designated length of time you must work before any stock options vest.
How this works
If your equity award has a 12-month cliff and you only worked for the company for 11 months, you wouldn’t get anything, since you haven’t vested in any part of your award.
Likewise, if the company you work for is sold within a year of your arrival, depending on your contract, you may receive nothing on the sale of the company.
A common vesting schedule is vesting over four years, with a one-year cliff. This means you get:
- 0% vesting for the first 12 months
- 25% vesting in the 12th month
- And 1/48th (2.08%) more vesting each month until the 48th month.
So, if you leave the company before a year is up, you get nothing, but if you leave after three years, you’ll get 75%.
When you exercise your options, you may incur a tax liability. This is something it’s wise to get advice on. In some cases, you may face a cost to exercise your options.
Wherever necessary, we introduce clients with stock options to an accountant who will read through your contract and understand all the tax implications, considering all your circumstances.
Plan before you exercise your stock options
A client we worked with recently had an option to sell around half his shareholding.
His biggest desire was to build his own home, and he wanted to understand how he could achieve this by exercising his stock options.
Using cashflow modelling, we worked backwards to figure out how much it would cost to buy the land and carry out the building work. From here, we could calculate how much of his shareholding he would need to sell and at what price to achieve his ambition.
Planning in this way is important because it helps you understand that there’s no point in just selling your options for the sake of it. In this case, it was crucial to have a well-formed plan.
Don’t let confirmation bias cloud your judgement
Some people struggle to believe it’s possible for a company they work for to do badly. There’s a confirmation bias that because the share price is going up, it’s always going to go up. Since there’s a vested interest in this being the truth, it’s hard to see the reality that a company that is doing well won’t automatically continue to enjoy growth at the same pace.
It’s important to separate your emotions from your decision-making and take an even-handed view when deciding how or when to exercise your rights.
Part of the work we do is to help you understand your emotional biases. We’ll help you remove emotional connection and work out a rational approach to achieve your life goals and objectives.
Since many share options are rewarded to employees in tech companies, it’s important to recognise that these can be high risk for all your money.
Having all your eggs in one basket is never a sound investment strategy.
Even if you have no immediate plans to spend the money you gain, selling a portion of your options and reinvesting the cash elsewhere may be a wise step to help protect your financial future.
Again, careful planning will ensure that you have time to take tax planning into account and can exercise your rights at the optimum time to benefit your financial objectives.
How we can help
At First Wealth, we will help you ensure you gain maximum benefit by helping you understand all your choices. We will use cashflow modelling to help you visualise your financial timeline and plan for what you expect to spend or gain throughout your lifetime.
If you sell shares but don’t have immediate plans to spend the money, we can devise and implement an evidence-based investment strategy designed to meet your long-term life goals.
We do not provide advice in relation to individual shareholdings (we would not offer an opinion on the future growth prospects of a company, for example).
Get in touch
If you’d like to find out more about how we can help you navigate your stock options and secure your future through evidence-based wealth management and financial planning, get in touch. Email firstname.lastname@example.org or call 020 7467 2700.
This document is marketing material for a retail audience and does not constitute advice or recommendations. Past performance is not a guide to future performance and may not be repeated. The value of investments and the income from them may go down as well as up and investors may not get back the amount originally invested.