Stock Options or Restricted Stock?

While vesting periods for stock options are usually time-based, they can also be based on the achievement of specified goals, whether in corporate performance or employee performance. Max Schireson on August 31, Ken on September 19, Or it may be that the company has to give permission even if you find a buyer. With early exercise, you can exercise options before they are vested. American options , which make up most of the public exchange-traded stock options, can be exercised any time between the date of purchase and the expiration date of the option. A vesting date is a common feature of stock options granted as part of an employee compensation package.

For example, your are granted 5, shares of stock at $4 per share in a startup. 5 years later, the stock goes public and three years after that it’s run up to $ per share. You can exercise the option, paying $20, to buy 5, shares of stock which are worth $1,,

Breaking Down the 'Stock Option'

That potential for personal financial gain, which is directly aligned with the company's stock-price performance, is intended to motivate you to work hard to improve corporate value. In other words, what's good for your company is good for you. However, by the same token, stock options can lose value too. If the stock price decreases after the grant date, the exercise price will be higher than the market price of the stock, making it pointless to exercise the options — you could buy the same shares for less on the open market.

Options with an exercise price that is greater than the stock price are called underwater stock options. Thus the word nonqualified applies to the tax treatment not to eligibility or any other consideration. NQSOs are the most common form of stock option and may be granted to employees, officers, directors, contractors, and consultants.

You pay taxes when you exercise NQSOs. For tax purposes, the exercise spread is compensation income and is therefore reported on your IRS Form W-2 for the calendar year of exercise. When you sell the shares, whether immediately or after a holding period, your proceeds are taxed under the rules for capital gains and losses.

However, to qualify they must meet rigid criteria under the tax code. ISOs can be granted only to employees, not to consultants or contractors. Also, for an employee to retain the special ISO tax benefits after leaving the company, the ISOs must be exercised within three months after the date of employment termination.

After you exercise ISOs, if you hold the acquired shares for at least two years from the date of grant and one year from the date of exercise, you incur favorable long-term capital gains tax rather than ordinary income tax on all appreciation over the exercise price.

However, the paper gains on shares acquired from ISOs and held beyond the calendar year of exercise can subject you to the alternative minimum tax AMT. This can be problematic if you are hit with the AMT on theoretical gains but the company's stock price then plummets, leaving you with a big tax bill on income that has evaporated. If you have been granted ISOs, you must understand how the alternative minimum tax can affect you. Stock option taxation is an important subject for all option holders to understand.

Now that you know the basic workings of stock options, you should learn the details of their tax treatment. Content is provided under arrangement with myStockOptions. Please do not copy or excerpt the myStockOptions. Thus, in general, an employer will grant more stock options than restricted stock. The value of an option is computed using either the Black-Scholes Pricing Model or a binomial pricing model. The value of restricted stock is the fair market value of the stock on the date of grant.

As a result, a corporation conveying a certain level of compensation to an employee in the form of equity will offer more stock options than restricted stock.

Of course, the stock options do not provide the employee with any economic value on the date of grant since the current value of the stock would be equal to the exercise price. So which would you take? The answer depends on where you think the price of the stock is heading. Changes are common, though 3x is somewhat unusual. You should ask if they have a notion of how the company would be valued today, but you might not get an answer.

There are three reasons you might not get an answer: If you can get a sense of valuation for the company, you can use that to assess the value of your stock options as I described above. One feature some stock plans offer is early exercise. With early exercise, you can exercise options before they are vested. The downside of this is that it costs money to exercise them, and there may be tax due upon exercise.

The upside is that if the company does well, you may pay far less taxes. If you do early exercise, you should carefully evaluate the tax consequences. By default, the IRS will consider you to have earned taxable income on the difference between the fair market value and the strike price as the stock vests. This can be disastrous if the stock does very well. In this case the taxes are calculated immediately, and they are based on the difference between the fair market value and the strike price at the time of exercise.

If, for example, you exercise immediately after the stock is granted, that difference is probably zero and, provided you file the paperwork properly, no tax is due until you sell some of the shares. Be warned that the IRS is unforgiving about this paperwork. You have 30 days from when you exercise your options to file the paperwork, and the IRS is very clear that no exceptions are granted under any circumstances.

I am a fan of early exercise programs, but be warned: What if you leave? The company has the right, but not the obligation, to buy back unvested shares at the price you paid for them. Taxes on stock options are complex. There are three times taxes may be due at vesting, at exercise, and at sale.

This is compounded by early exercise and potential 83b election as I discussed above. This section needs a disclaimer: I am not an attorney or a tax advisor. I will try to summarize the main points here but this is really an area where it pays to get professional advice that takes your specific situation into account.

I will not be liable for more than what you paid for this advice, which is zero. NSO gains on exercise are taxed as ordinary income. When you sell the shares, you owe capital gains short or long term depending on your holding period on the difference between the value of the shares at exercise and when you sell them. Some people see a great benefit in exercising and holding to pay long term capital gains on a large portion of the appreciation.

Be warned, many fortunes were lost doing this. What can go wrong? But, in an attempt to minimize taxes, you exercise and hold. But how do you pay your tax bill? The situation is a little different, but danger still lurks.

In the best case, ISOs are tax free on exercise and taxed as capital gains on sale. However, that best case is very difficult to actually achieve. The situation becomes more complex with limits option value for ISO treatment, AMT credits, and having one tax basis in the shares for AMT purposes and one for other purposes. This is definitely one on which to consult a tax advisor.

In the case of liquid stock options say, in a public company , in my opinion this is exactly as they are intended and a healthy dynamic: If you leave, you give up the opportunity to vest additional shares and make additional gains. But you get to keep your vested shares when you leave. In the case of illiquid options in successful private companies without a secondary market , you can be trapped in a more insidious way: This is a relatively new effect which I believe is an unintended consequence of a combination of factors: Until then to adapt a phrase caveat faber.

Private equity funded companies often have very different option agreements; recently there was quite a bit of publicity about a Skype employee who quit and lost his vested shares. The theory behind reclaiming vested shares is that you are signing up for the mission of helping sell the company and make the owners a profit; if you leave before completing that mission, you are not entitled to stock gains.

In general, your vested options will be treated a lot like shares and you should expect them to carry forward in some useful way. Exactly how they carry forward will depend on the transaction. In the case of an acquisition, your entire employment not just your unvested options are a bit up in the are and where they land will depend on the terms of the transaction and whether the acquiring company wants to retain you.

In an IPO, nothing happens to your options vested or unvested per se, but the shares you can buy with them are now easier to sell. In a cash acquisition, your vested shares are generally converted into cash at the acquisition price. In the case of a stock acquisition, your shares will likely be converted into stock in the acquiring company at a conversion ratio agreed as part of the transaction but you should expect your options to be treated similarly to common shares.

That could actually be counterproductive for option holders. Lot of it depends including whether they keep the employees at all. But often they are converted to options in the new company. Probably nothing to do about it besides quit though I am not a lawyer and you might ask one if there is a lot of money involved.

How long did you work there without the options being granted? Up to a few months is normal, past that is unusual. I worked there for 6months part time and another 6months full-time. Did the board meet during the time after you accepted the offer and started and prior to the acquisition and how many times? Did it review your proposed grant at the meetimg and if not why not? If it reviewed your proposed grant why did it not approve it?

On what basis was your new grant determined? Did they convert the grant in your offer letter based on the terms of the purchase or did they just give you stock in the acquiring company as a new employee of that company?

This could have been ongoing from the time you joined, or started shortly afterwards but have been in progress at the first board meeting after you joined. If this was the case, the board may have been in a very hard situation with respect to valuing the stock options.

If the acquisition discussion was credible enough, it would be material information that could force a re-evaluation of the fair market value of the shares.

To avoid the risk of grantees you being liable for huge tax penalties, they would likely have wanted to retain a third party to do the valuation. Hiring the firm takes time, the valuation takes time, and board approval of the valuation takes time.

During that time, the discussions might gave progressed — maybe they got a second higher offer. That could restart the clock. In any case, even if they were able to complete the valuation and grant the options, the valuation may well have been quite similar to the price offered by the acquirer and those options might have been converted to options in the acquiring company at a similar strike price to the price of your grant.

If the value of the stock underlying your new grant number of shares times strike price is well in to the six figures or beyond, it may be worth consulting an attorney just in case, but my guess and I am not a lawyer is they are going to say that you just had bad timing.

I too think that I should have gotten either an approval or decline of my options , neither was delivered to me, hence I believe this is a direct violation of my employment agreement. My options never materialized, I basically got the buying company options at a strike price which is the share price in the day of the buyout which means zero profit!

My guess is that you make some enemies with this post. It is clearly to the advantage of the company that the terms of stock options and vesting periods remain opaque.

What if there were liquidity in options? That would be interesting, and wildly dangerous, I imagine, because such liquidity would be so predominantly speculative in the absence of knowledge of company fundamentals.

A successful growing company grants millions of dollars worth of options each year, and I think it works to their advantage to have people understand their value and thus make rational decisions about them.

That is certainly the case for well known private companies eg, Facebook , and sometimes is the case for smaller companies as well; question is can you find an investor who wants to buy the shares. Often this will be restricted for current employees but more open for ex-employees. This can be very complex and the SEC has rules about shareholder counts, how the shares can be offered etc.

Hello, I just received an employee stock option that would allow me to buy shares within five years. Do I have to buy the shares right away? If I buy the shares now and after 2 years I left the company or they fired me, do I still have the right for my shares? I really appreciate your advice. Really sorry for the delayed reply.

Usually you have all 5 years. Usually you can buy some now and some later. Tax issues vary, research them carefully. Well written for sure. A small company was bought by a larger one and the employee was given her recalculated options.

There are 2 years left on this employees vesting schedule. Without any prior negotiation at time of hire regarding acceleration of vesting, is there any way receive acceleration in case of termination? That means that their employer is under no obligation to keep them employed until the end of their vesting period or for any other reason. They can be fired because of a lack of work for them to do, a desire to hire someone less expensive to do the same job, a desire to restructure and eliminate their job, or because the company is unsatisfied with their work.

By treating the terminated employees nicely, the remaining employees are less likely to panic. Normally one should expect to vest only as long as their employment continues. How do unvested options work post-IPO? Is an IPO an event that can trigger acceleration, or is this reserved for acquisition typically?

Can unvested shares be canceled post-IPO? It is very unusual for an IPO to trigger acceleration. While it is easy to see an IPO as a destination for a startup, it is really the beginning of a much longer journey. An IPO means that a company is ready to have a broader base of shareholders — but it needs to continue to deliver to those shareholders, thus it needs to continue to retain its employees.

Occasionally companies will give people the option to stay for reduced option grants but that is unusual. Family businesses and business that exist outside that ecosystem of startup investors, lawyers, etc may have different arrangements.

What happens if you exercise pre-IPO stock options within 90 days of quitting and the company never goes public?

Then you own shares that may be hard to sell. The company may be acquired and you might grt something for your shares, or in some circumsances you can sell shares of private companies. But the money you pay to exercise the shares is at risk.

This entire article and your answer to my question has been the best write up on this topic that I could find on the Internet. I received the agreement, signed it, and got a copy of it back signed by the corporate secretary. I never received any other documentation since. Should I contact HR or a financial advisor? Just slightly concerned since the company seems a little secretive to me.

I have been with them for over 6 years. Usually you have 90 days after leaving until you have to exercise the options, but this varies from plan to plan and the details should be in the paperwork you signed. One data point that you will need to finalize your decision is the FMV fair market value of the shares for tax purposes.

The company should be willing to tell you this; if it is quite a bit more than a penny some taxes will be due on exercise but the shares are more likely to be worth something.

Thanks Max, I really appreciate it. After reading your article and doing some research I found out I was looking at the par value, not the exercise price.

So in my case, I would be severely underwater. Thanks again for sharing your knowledge! Max, thanks for the great info. I am considering joining a tech startup and wonder if there are enough benefits for both the company and myself for me to be brought on as an independent contractor vs.

Any info you have or can refer me to would be helpful. Sorry for the delay. But even then, you will probably not get benefits or stock options. Good luck with your decision. The terms of preferred stock vary, not only from company to company but also across different series of preferred stock in a company. I may not have time to answer but feel free to try me first initial last name at gmail. Hi Max — thanks for the insightful article.

Why do companies issue stock options?

Exercise Stock Options: Everything You Need to Know Startup Law Resources Venture Capital, Financing. You exercise 5, options and purchase 5, shares. In this scenario you will owe an AMT of $5, (5, shares x 28% federal AMT tax rate x ($5 - $1)). Breaking Down the 'Stock Option' Stock options normally represent shares of an underlying stock. Therefore, if the premium (cost) of an option is $, buying one contract costs $10 ($ x. Aug 30,  · We have stock options with a company that is not yet publicly traded. It is ISO. If we exercise shares at {{nazokblog.tk}}, - Answered by a verified Tax Professional5/5.