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The Five Biggest Stock Option Mistakes –
For many jobseekers, stock options have become the Holy Grail. They are the key motivators in beginning a job search and the one perk that can tip the scales in favor of accepting a particular job. But while they may be the most tantalizing part of any prospective new job, stock options are also the most complex to analyze. It’s straightforward to calculate the value of health insurance or a company car, but stock options are a different sort of benefit. For example, how do you place a value on 20,000 options in some upstart dot-com?
As a consequence, many jobseekers try to simplify the process and, in the process, may end up shortchanging themselves or making unrealistic demands of prospective employers. Here are the five most common mistakes jobseekers make when negotiating for stock options:
1. They focus on one number. Most commonly, jobseekers have it in their minds that they want options for a certain number of shares–perhaps 50,000 or 100,000. This decision may stem from doing the arithmetic and deciding that appreciation of $10 per share would meet their personal goal of making $500,000 or $1 million via their options. Less commonly, they focus on the length of the vesting period for options to be available for purchase. They may have it in mind that the options should vest in two years and refuse to consider a job in which the options vest over a three-year period. The reality is that a single number can be highly misleading. For example, options for 25,000 shares at one company may be potentially more valuable than options for 50,000 shares at another company.
2. They go by what their friends have obtained. In this scenario, a computer programmer who wants to change jobs may have a friend with similar skills who obtained a stock option package for a certain number of shares at a particular price. The job-seeking programmer decides he wants the same package at another company in terms of number of shares, pricing, vesting period, and so forth. The problem with this approach is similar to the previous one—you’re likely comparing apples and oranges. Chances are that the two companies are at different stages and have different valuations, so the same number of shares or price per share at one company wouldn’t be appropriate to demand of a different company. That’s not to say you shouldn’t inquire as to the kinds of option packages that are offered to other employees at your prospective employer; information here can help guide you on what’s appropriate to hold out for.
3. They take whatever package they’re offered. Many individuals are intimidated by the subject of stock options and the terminology surrounding it (incentive stock options, non-qualified stock options, strike price, etc.). So instead of asking questions or investigating, they simply nod their heads in agreement as a proposed stock option package is described and hope that the company is doing right by them. The fact is that a stock option package is a negotiable item, just like salary. But you need to be able to make a case as to why the package should be more attractive, and to do so, you need to understand the terminology and logic behind options.
4. They neglect the tax implications. Unfortunately, the tax implications of options are potentially costly and very complex, to the extent that even tax experts disagree about certain rules. The reality is that such factors as the type of options you receive, when you receive them, and actions taken by your company (going public or selling to an acquirer, for example) can have huge tax repercussions for you as an employee option holder. Generally speaking, incentive stock options (available only to employees but not to outside contractors) are preferable to non-qualified stock options (available to both employees and outside contractors) for tax purposes. As far as timing is concerned, you could join a company a few months before it is acquired and, based on exercising your stock options, have a tax liability that requires you to pay out more cash to the IRS than you netted for exercising your stock options. This can occur if the acquisition is in exchange for cash and stock, and you wind up having a tax obligation for the value of stock you received but are prohibited from selling for six months to a year. (As I said, it’s complex.) You need to know which questions to ask to avoid such a scenario, and in some cases, you may even want to speak with an accountant before taking a job where you’re uncertain about upcoming events like an acquisition.
5. They approach a stock option offer as an all-or-nothing decision. The offer you receive for stock options when you join a company isn’t necessarily the only one you will receive. Additional stock options can be offered at any point during your tenure at a company. They can be part of a salary review. You may even secure a commitment that additional options will be forthcoming if you and/or the company meet certain objectives (like achieving sales quotas or completing product development by a certain date). Even without a specific commitment in advance of joining a company, you should know that it’s appropriate, and sometimes preferable, to seek out a significant part of any raise in the form of stock options during a salary review. Stock options cost a company much less than cash, so in cases where employees feel strongly that they’re entitled to a larger raise than an employer is offering, seeking out additional stock options can help break a logjam. Many employees accumulate more stock options over the course of several years of employment at a particular company than they do upon initially accepting a job.
6. The key is to analyze key aspects of the entire situation. You need to be able to attach a market value to yourself as an employee. And you need to be able to place a value on any options you are being offered. What your friends received at another company or what you want in order to become a millionaire is irrelevant. In the final analysis, the marketplace dictates what’s appropriate. It’s up to you to educate yourself about the marketplace so you negotiate the best possible deal for you.
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