Before you consider accepting stock options at your new place of employment, here are six factors to keep in mind and evaluate.
1. Have Stock Options Been Priced At a Fair Market Value?
In addition, consider the exercise price in relationship to the preferred stock price. Often startups backed by venture capital firms will issue employees stock options that come at an exercise price significantly less than what investors have to pay. A simple rule of thumb is to consider your options in relationship to the price of your preferred stock.
When your options are close to the price of preferred stock, then your options have less value. Essentially, you are looking to get a discount. The IRS puts limitations on how big this discount can be. (For more from this author, see: Understanding Your Employee Stock Options.)
Anything over 67% would actually burden you with a tax liability because you benefited from a gain on exercise price way below the fair market value. You would have to pay taxes on the difference for each share. In the best case scenario, you can get a discounted exercise price that falls below the IRS threshold, thus avoiding the tax liability and still benefiting from a sizable price difference.
2. When Did Company Have Its Most Recent Common Stock Appraisal?
Often you do not know the exercise price of your stock options when you get your job offer. You won't learn the price until the common stock meeting is held. Private employers determine the exercise price using a 409(a) appraisal that is done usually twice a year. Often the exercise price increases, meaning your options have decreased in value.
3. Consider Company’s Potential Valuation
Each company varies. What do you think your company will be worth in a few years? You can ask your employer this to understand the logic behind their number projections. Typically, you can make more money on stock options when your company increases in value, rather than through receiving a bigger grant offer.
4. For How Long Is Company Funded?
When a company has to constantly seek out additional funding, dilution of stocks occurs. You will have to take this into consideration because your shares will have changed value in comparison to the market. (For related reading, see: Get the Most out of Employee Stock Options.)
5. Consider Amount of Money Company Has Already Raised from Investors
For a company that raised a lot of funds and then was sold, venture capital investors will receive the first proceeds from the sale of the company that will match their investments. Only after they have recouped their investments will the company's preferred stock be converted into common stock. A company that raises a lot of money but does not have much progress, or profit, will most likely fail to provide you with valuable stock option benefits.
For many companies that raised a lot of funding ($1 billion or more), the process through which the the employer issues restricted stock units (RSUs) is different. You receive a benefit regardless of a change in the company value. Stock options in this scenario can only grow in value when the company value goes up, and this may take a long time.
6. Consider Follow-On Stock Grants
Some companies offer extra stock to employees after they have started as a way of rewarding excellent performance. It is also a way to retain high talent and vested employees. In this scenario, you may have more stock options available to you after your initial four years at your current employer, for example, than if you joined a new company.
A Longevity Incentive
Stock options can be a wonderful incentive to work at a company for a longer period of time. Some companies are known for excellent stock options.
For example, FactSet Research Systems Inc. (FDS), a financial services company in Norwalk, Connecticut, offers a stock purchase plan every quarter that gives employees the opportunity to invest 1% to 10% of their base pay (after taxes). FactSet employees can join the plan on their first day and the company also provides an equity awards program with a variety of stock options.
Internet services provider GoDaddy Inc. (GDDY) went public in 2015 and offered employees non-qualified stocks. Most employees chose to hold on to the stock instead of trading. GoDaddy also has a stock purchase plan where employees can buy and sell stock at 15% every six months.
Having more knowledge about the specific stock options that your prospective company provides can help you in your decision-making process. (For related reading, see: Avoid Premature Exercise on Employee Stock Options.)