Today I want to talk about some important things everyone with equity compensation should be doing. Now, I have titled the article the biggest mistakes to avoid, however, I really don’t like being negative. It is a result of negative articles getting more clicks. The actual approach I will be taking as I move through these items are these are some of the most important things you should be doing if you have equity compensation and you want to be successful with it.
Before we jump into things I want to share a quick reminder. I cater to employees with equity compensation and work for publicly traded companies. My focus is on RSUs, stock options, Restricted Stock and ESPPs. I do not work with startups or things like IPOs. It just is not my area of knowledge. If you are looking for an advisor who works in that area, well, I am not the person. With that, let’s get to it.
The first important thing you should do to be successful with your equity compensation is an easy one. At least it is easy for me to explain. It is simply making sure your In-The-Money Stock Options never expire without you exercising them. As a reminder, In-The-Money simply means they have gone up in value from the price at which they were awarded to you. They now have value and are worth money to you. This is why some of my clients call them Show-Me-The-Money options. Regardless, if they have gone up in value and are now In-The-Money be sure to exercise them so you now have full ownership of these shares. 11% of In-The-Money options are never exercised. That just boggles my mind, but I get it. Most stock options have a 10-year time period for you to exercise them. Be sure to pay attention to time periods and if the stock is now up from its starting point.
Success item number two is directly connected to the previous point. Heck, it is connected to every point I am going to mention. So, you can confidently say this is the most important of all the things you can do. Even more important than hiring me. Please note sarcasm font, sort of. The item is to please, please, please take the time to understand your equity compensation. When you become eligible for your equity compensation your employer will provide you documents to explain them. First, make sure you don’t throw away these papers. More importantly, take the time to read through them and know what it all means. If this results in you having to hire someone to help you, then I believe it is money well spent. At a minimum, ask questions of your employer.
You need to understand your equity compensation so you can figure out things like exercising stock options, when you are eligible for RSUs and Restricted Stock, enrollment details for your Employee Stock Purchase Plans, vesting for everything, what happens when you retire or leave, and even what happens if the company is acquired, and much more. Odds are it will not be fun reading, but it is worth the time, especially if you want to be successful with your equity compensation.
Alright, let’s talk another simple one. If you have an ESPP, odds are you should be participating in it. The reasons are varied, but let me share a few. Oh, as a reminder, ESPP stands for Employee Stock Purchase Plan. ESPPs are my favorite form of equity compensation plans. It is simply because just about everyone can participate in one if you are a full-time employee. Next, the way ESPP plans work is you have the opportunity to buy company stock through payroll deduction. And, the stock is typically at a discount. Current rules are your employer can discount the stock by a maximum of 15%. Be sure to confirm with your employer the actual discount for your situation. The current maximum you can put into an ESPP is $25,000. Now, these are purchased with after-tax dollars so it is different than a 401k contribution. However, the fact everyone can participate and get a discount is what makes my love ESPPs.
If you know me you know I have to talk about Concentration Risk. This is simply how much of your net worth is in one position. Now, there is no single rule saying X is the correct amount of concentrated stock you should hold or maybe never go above. No, it is different for every person. The one question you need to answer is – If I did not work for this company, how much of their stock would I own on the outside? Again, the answer is personal to you. It is important for you to identify what that number is for you and check on a regular basis in case you go above it. Getting too concentrated could result in a disaster. This is why it is critical to develop your number and pay attention to it, at least on an annual basis.
The next successful task is my favorite – taxes. You know me and not wanting to tip Uncle Sam. Again, nothing illegal or even questionable. Simply taking advantage of tax rules to make sure you are keeping more of what you make.
Taxes are an interesting situation. They are kind of like Goldilocks as there is a balance you must reach with them. I mean you must pay attention to taxes to be sure to minimize them, however, I have seen people obsess so much about taxes they lose sight of the big picture. I guess they focus on the trees instead of the forest.
Regardless, it is important to pay attention to things like whether an 83b election makes sense in your situation. Or, how much of your stock options will need to be exercised this year increasing your tax bill. And if you are receiving RSUs, what amount of these will be vesting which means your income will again be going up this year.
On the flip side, you can easily let taxes hinder your success in a case where you are above your Concentration Risk number but refuse to sell and reduce your positions because it will mean a higher tax bill. This is a case where the tax tail is wagging the dog. Same thing applies in situations like letting In-The-Money stock options exercise unexpired because you don’t want to pay more in taxes, although the net effect is your net worth would increase with the newly exercised options. It reminds me of the situations where people complain of how much they would have to pay in taxes if they won the lottery. Yeah, you may pay out more, but at the end of the day your bank account will be much larger. Regardless, developing a solid plan will help you maintain the right balance and be sure the bed is not too soft or too firm.
I just mentioned developing a plan. Maybe this is the most important point if you want to be successful with your Equity Compensation? It is definitely in the top 3. Ultimately, you need to develop a plan. Whether that is by yourself or with the help of a professional. All of the items I mentioned should be in your plan. Things like tracking your stock options so you know to exercise them and not let them expire. Also, staying under your concentration risk number. Planning effectively around your tax situation so you are not tipping Uncle Sam and also not losing sight of the big picture. Also, to understand things like what happens if you leave your job or the company gets acquired. Simply understanding the rules of your equity compensation documents should also be in your plan. Now seems like a good time for the old expression of failing to plan is planning to fail.
The final important step to be successful with your equity compensation is one personal to me. It is taking the time to hire a professional who focuses in this area. Obviously there is some self-interest here as this is what I do. And to be honest, you can do this on your own. The question is whether you want to spend the time and energy doing it. Only you can answer that.
Regardless, my point is if you are looking to hire someone who does this please take the time to find someone who actually caters to this world. There was a comment shared with me years ago when I worked at Merrill Lynch. It was an offhand comment by a senior advisor and went along the lines of trainees cost the company $75,000 but cost clients $750,000. The point is you want to hire someone who is not using you as a guinea pig hoping things work out for you. And I’ll be honest, that is why I turn away potential clients who want help on things like IPOs. As I mentioned at the beginning, I focus on employees of publicly traded companies. If I took on someone who worked for a startup and had IPOs, well, it would be like that Merrill Lynch situation.
I’m Dan Johnson, CFP®, founder of Forward Thinking Wealth Management. I run a flat-fee financial planning and investment management firm located in beautiful Akron, OH. Although I am in Akron, OH, I work with clients regardless of location. I cater to owners of equity compensation positions who are looking to organize their financial lives, keep more of what they make, and do the things they want in retirement and even now.