A stock option is a security that grants employees the right to purchase shares in the company they work for at a pre-declared and reduced rate. It is one of the most profitable and attractive benefits of working for an employer and, depending on the company’s policy, it can be granted to new employees at the outset of their contract.
Once an individual leaves the company, however, their stock options also become void and, if nothing further is done, it can be a terrible financial loss for that employee. Fortunately, it is possible to turn this financial loss into a gain if a few simple steps are taken and the right decisions made.
The first thing to consider when leaving a company is the holding period. Generally, stock options cannot be exercised until the employee has be employed for a certain period and it is important to understand when they are eligible to do so. For example, in many tech companies, the standard holding period is four years.
Different companies have different vesting policies, which also need to be taken into account and read carefully. This will define the percent of the option that the leaving employee is entitled to when their employment terminates. It is worth noting that, in spite of the termination of employment, the vesting period may continue regardless. So, the employee will still benefit from any appreciation in the stock price of the company, which in turn means the worth of the stock options increases as time goes on.
When leaving a company, stock options also often become devalued by the price of the stock itself. This happens when the company’s share price has fallen since the employee initially received the stock option. In such cases, the employee can look to mitigate the effects of this decline by exercising their options early. This means that they pay the reduced rate and the stock is transferred to their name. This will at least recoup some of the cost and prevent them completely losing out.
It may also be possible to sell the stock options after leaving a company, depending on the terms and conditions of the contract. As soon as the employee leaves the company, they should check the terms of their employment to confirm if this is allowed.
One of the final options, and perhaps the most final, is to simply take the loss. This can be a hard decision to take, particularly if the employee has been with the company for quite some time. However, if the stock price has plummeted since they received the option and their clawback period has expired, it may be their only option.
What Are The Benefits Of Having Stock Options?
When the right decisions are made, stock options can be extremely beneficial for the recipient. By exercising the option early, they can become a shareholder and benefit from any gains that are made in the future. Furthermore, stock options frequently have a generous vesting period, which means that the employee can benefit from any appreciation in the value of the company’s stock as it rises over time.
Stock options also offer employees a source of income that does not require a great financial investment. With stock options, an employee can benefit from some of the same financial rewards that full-scale shareholders enjoy without the need for any financial outlay. As a result, it can be an attractive and low-risk source of revenue for employees.
What Are The Drawbacks Of Stock Options?
Stock options are not without drawbacks. If they are not managed correctly, they can lead to a great deal of financial loss. If the stock price declines after the employee exercises the option, they have taken of the cost of the stock and lost the benefit of the reduced rate.
Stock options are also very time-sensitive. If the employee leaves their company their options become void and they are unable to benefit from any long-term appreciation of the stock. This means that the employee must exercise their option and manage the situation correctly before their contract terminates.
How To Utilise Stock Options If Leaving A Company?
When leaving a company, it is important for employees to carefully consider their stock options and how to best handle them before their contract ends. Firstly, they should take into account the company’s vesting policy and determine the percent of the option that they are eligible for. Secondly, they should identify the holding period and decide whether it is more profitable to wait or to exercise the option early.
More adverse circumstances, such as when the stock price has fallen, can be mitigated by exercising the option early. This allows the employee to recoup some of the cost and offset some of the financial losses that would have been suffered had they done nothing.
Employees can also look to sell the option on the open market if their contract allows it. If they can find a buyer, they can still benefit from the appreciation in the stock price, even though they have left the company. In the last resort, if it has become impossible to exercise the option, the employee can forego their rights and take the financial loss.
Should I Grant And Receive Stock Options?
Generally speaking, granting and receiving stock options is a great way to benefit financially. It can offer employees a source of income that is low-risk and while the recipient will benefit from any appreciation of the stock price, there is no financial outlay required. This makes stock options ideal for those who have restricted access to finances.
For employers, granting stock options is also a great way to attract new talent. By allowing a potential employee to purchase shares at a reduced rate, they create a much more appealing financial incentive. This is why stock options are so common in the tech industry, where current and potential employees can benefit from the success of the company without the risks usually associated with startups.
How To Manage Stock Options Risk?
Unfortunately, there is no risk-free way to manage stock options. It is always advisable for employees to consider the risks and to also understand the company’s policy in regards to the vesting period and the holding period. This will help them to better understand their situation and identify the option that best suits their needs and circumstances.
It is also prudent for employees to consider how the stock price of the company has changed since they first received the option. If it has declined and the employee is close to the end of their contract, exercising the option early is often the only option to prevent a financial loss. Finally, employees should not rely solely on stock options as a source of income and should diversify their portfolio.
What Are The Tax Implications Of Stock Options?
Tax rules around stock options can vary depending on the country and its laws. Generally, however, an employee’s tax liabilities will increase when they exercise their options. This is because, after the options have been exercised, the employee has now become a shareholder. As such, any profits made by the employee must be declared to the government.
If the employee exercises their option early, they will also incur a tax payment on the difference between the vested rate and the market rate. This payment will then tif they cannot pay the full rate, they may be able to negotiate a contract with the government to pay off the difference in installments.
When leaving their employer, the employee should also be aware of the clawback period. If the employee has made any profits over the course of the clawback period, they will be liable for a tax payment corresponding to their capital gains. Depending on the size of their earnings, this could be anything from a few hundred to several thousand.
What Are The Legal Considerations Of Stock Options?
Legal considerations are of paramount importance when managing stock options. Firstly, the employee should be thoroughly familiar with the company’s policy. This will ensure that the employee knows their rights and what the terms of their contract entail.
If the employee does not understand the terms of the contract, they should not exercise their options as this may lead to an expensive or unjustifiable financial loss.
Employees should also consider the hidden fees associated with stock options. Buying and selling stocks can be an expensive process and the employee may incur fees associated with appointments, commissions, and legal documents. Therefore, it is important to understand what fees will be deducted and to calculate a potential return on investment.
Finally, employees must stay across any changes to the company’s policy, or any changes to the laws that affect stock options in their country. Such changes can have a dramatic effect on the value of the option and can restrict the employee’s ability to exercise their option. Therefore, it is important to stay informed and exercise the option accordingly.
