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Equity Compensation – The Basics

EQUITY COMPENSATION – THE BASICS

Welcome to the Equity Compensation series!  Maybe you are brand new to receiving equity compensation or have been receiving equity compensation for years but want to get a better understanding of it and how it impacts your retirement.  Well, in my mind it is important to start at the beginning with some basic definitions.  Let’s jump into it.

  • Restricted Stock Units
    • This is a right to receive stock after you have satisfied any conditions imposed by the company.
    • The conditions can be working for the company for a certain amount of time or a sales goal.
    • If you meet the conditions you get the shares. If not, well, then you don’t get them.

 

  • Restricted Stock Awards
    • This can also be called a Restricted Stock Grant, or Stock Grant for short.
    • It provides essentially the same benefit as a restricted stock unit.
    • The difference is you get the shares at the time they are awarded to you.
    • If you do not meet the conditions the company may take them back though.
    • Due to this unique structure the shares may be held in escrow, so it is easier for the company to reclaim if necessary.
    • One advantage of restricted stock awards is you may receive dividends and be able to vote, unlike RSUs.

 

  • Stock Options
    • This is an agreement that provides terms under which you can buy a specific number of shares at a set price.
    • The hope is the value of your options will grow as the company’s stock price increases.
    • If the stock’s value goes down you haven’t lost anything because you don’t own the shares, you just have an option to buy them.
    • Some experts call this a free lunch – you benefit if the value of the options go up in price and you have no risk in case the value goes down.
    • There are two types of stock options
      • Incentive stock options, also referred to as ISOs
      • Nonqualified options

 

  • Grant or Award
    • When you receive the stock option.

 

  • Vesting
    • How long you have to wait before you have full ownership rights, and you cannot sell the stock during this period. It is set by companies.

 

  • Blackout Periods
    • These are times when companies prevent employees from selling shares. It usually happens around annual or quarterly reports, you know, sensitive times. Companies may then refer to periods when you can sell as Window Periods.

 

  • Lockup Period
    • This applies to private companies who go public. There are restrictions put in place to prevent you from selling during a set period of time after the public offering.

 

  • Exercise
    • When you notify the company you want to purchase the stock and provide payment according to the terms of the option.

 

  • Exercise Price
    • Price you pay when you exercise the option. If you have an option to buy 100 shares at $5 a share, your exercise price is $5. Also known as strike price, option price or striking price.
  • Expiration
    • Be aware that stock options do expire. Most options

 

  • Spread
    • Difference between current value of stock and the exercise price. For example, current value is $9 a share and your option price is $5, the spread is $4.

 

  • In the Money
    • When the spread is positive, such as the previous example.

 

  • Underwater
    • When the spread is negative. So, the current value is $3 and the option price is $5, you are negative $2 per share.

 

  • Option Agreement
    • Expect this from your employer when you are granted an option. It will have all the important information about the options.  You often get a Prospectus with this.  Most employers have formal Stock Option Plans so remember to ask for a copy of this too.

 

  • 83b
    • Is a provision under the tax code which gives you the choice of paying taxes on the total fair market value of the restricted stock at the time it is granted.

 

About Dan Johnson, CFP

I am the President and CCO of Forward Thinking Wealth Management, LLC, which is the flat-fee financial planning firm located in Akron, OH, and set up to work virtually with clients across the country. I charge clients a flat fee of $4,800 regardless of asset size. My firm is a solution to what I feel is a broken system where clients pay advisors based on something out of their control - the performance of the market.
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