Stock options payout

This page is based on personal experience, and is based on what I know of American tax law. I am not a lawyer, however, and can not claim that this information is currently accurate. Use it at your own risk. See also a paper on stock I wrote for fellow employees of a company several years ago.

It covers a bit more material, and goes into more depth on some topics. You can get paid in stock or in options. If you get paid in options, you receive the right to buy the stock later, at a set price. If the stock is selling on the open market for more than the strike price, you can exercise the option, buy the stock for the strike price, and then sell it immediately for the market price, pocketing payout difference as profit. The lower the strike price, the more profit you make.

That means that the maximum profit the option holder can realize is movement in the stock price after the time options are issued. With stock, there are no cash flow concerns. Once you own the stock, you own it. With options, however, you need to come up with the money to exercise the options. Rarely—and never in a venture backed options professional investors—will you be given that ability.

The holding period can range from 6 months to 3 years. The intent of this is to prevent monkey business in which insiders are allowed to purchase pre-public shares immediately before an IPO and then turn right around and sell them. In fact, there is currently a strong movement in congress to eliminate the holding period.

To make matters worse, taxes can cause a cash flow issue in all of this. When you exercise the options, the difference between the option strike price and the market price of the stock is treated as normal options, taxable at your full tax rate. Your full tax rate can be quite high, once state and federal are both taken into account.

When you sell payout shares you acquired by exercising your options, any up or down movement in the share price since the date of exercise counts as a capital stock or loss. Possibly subjects you to the alternative minimum tax AMT. When you sell the shares, the difference between the strike payout and the share price is taxed. If the shares have been held for less than a year, the normal income tax rate is payout.

If they have been held more than a year, the capital gains rate is used. If you want compensation that vests over time in a private company, stock may be a poor choice. As each block of stock vests, it constitutes taxable income equal to the fair market value of the stock at the time of vesting not at the time the contract is written.

You have to come up with the cash to pay the taxes some other way. Options are more palatable, but they introduce a quandry. In a private company, you would like to exercise options options as soon as possible.

You will start the liquidity counter ticking early, so your holding period will be over by the time the stock is tradeable. And if your options are not incentive stock options, stock will generate a normal income tax rate hit. You also want to take that hit which happens at exercise time on as low a stock value as possible, and have most of your gains happen as a capital gain or loss.

But on the other hand, you might not want options exercise your options until the company goes public. The shares you receive from the exercise will be fully liquid, and you can trade them immediately. But your stock gain market options minus strike price will be taxed as normal income.

That can be a huge incremental tax burden. Whether to exercise options while a company is still private is a complicated, individual question. The answer depends on your regular tax brackets, your capital gains brackets, stock long you think it will be until the stock goes public, and how much money you have to pay taxes on the options exercise.

Stock, then you have to find someone to buy your shares if you want to make any money off them. Payout happens if more stock is issued to give to new investors?

Your shares get diluted. If you are in a very powerful negotiating position, you may be able to get an anti-dilution provision, which lets you maintain your percentage ownership in the firm even when new shares are issued. What if the options gets bought out while I own options or stock? This depends on your agreement and the terms of the sale. An IPO or acquisition can drastically change a company, effectively making it a different place than you signed up to work in originally.

If you can swing it, the safest thing to do is to require that your options or shares vest immediately upon stock public offering or acquisition. How much should I ask payout As much as you can get. A few very, very rough rules of thumb: They effectively traded salary for equity without options enough stock to compensate them for the risk they took or for the fact that it took two years before they saw the money.

Keep in mind that subsequent funding rounds will dilute you. What matters is the percentage you own when the company goes public or is acquired. The percentage you own today may be less relevant. It depends what percentage that is of the company. If the company is the next AMAZON. See the essay on Equity Distribution to get an payout of what percentages are good options. You are investing your time and reputation with the company. Any aboveboard company would instantly reveal those numbers to a monetary investor.

Without knowing the percentages, you can not evaluate the value of your options. Companies split their stock immediately before going public, or they reverse-split their stock, to adjust the share price.

You may have 30, options today, but a pre-IPO reverse split of 1-for-2 will leave you with just 15, shares after the Payout. One was 2-for-3, the other was 1-for-2 reverse split. Once you know what percent you own, find the value by multiplying the expected company valuation by your percentage ownership at IPO. Remember that the IPO itself dilutes all shareholders.

But how do you know that 3, shares today will still be 3, shares at IPO? Does the company care if they give me stock or options? They may, but if they do, it is only because of the accounting treatment or administrative stock of giving out stock. Either way, they are giving you ownership or an option of ownership in the company. We look forward to options Stever address our group again!

All rights reserved in all media. Things to Know about Stock vs. Download my lessons on Stock and Options. Stock Get-it-Done Guy podcast. Pamela Waite, Vice President, Programming, Society of Professional Consultants. The right to buy or sell stock at a predetermined price.

The price at which an option lets you buy stock. The price at which stock is selling on the open market. You rarely receive stock or options all at once. The schedule over which shares or options vest. Often, a person receives a certain number of shares each quarter or each year. If the company issues an additional 1, shares to investors, there are now 2, outstanding shares. This is called dilution.

When a company is public, its shares are registered with the SEC. Options which get special tax treatment: No tax hit when exercised. If you are receiving actual payout shares that vest, the moment they vest, the amount vested becomes treated as normal income, taxable at your full tax rate. When you sell your shares, you realize a capital gain or loss on any movement in share price from the time that you stock the shares.

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