Calling all tech employees! Does any of the following apply to you:
- You’re part of an emerging technology company
- You’re juggling several forms of compensation in the form of equity (equity comp.)
- You’re not quite sure how to intentionally use your equity to reach your goals
- Your equity is overwhelming and you aren’t sure where to start.
If any of these apply to your situation, we’re here to help.
On top of your daily work responsibilities, you are tasked with sifting through the minutiae of stock option logistics. From grant dates and vesting schedules to diversification and tax considerations, it’s seemingly a full-time job just to keep everything straight.
As easy as it might be to neglect these investments and tuck them away in the “do not enter” section of your brain, it’s critical that you find a strategy that works for you and your unique situation.
How do you manage your equity compensation without driving yourself crazy? What are the high-impact decisions you must make to ensure financial success? How do you create a strategy that does not require an endless amount of maintenance?
Let’s dig in.
Treat Your Equity Like Part of Your Paycheck
At Rivermark Wealth, we like to encourage our clients to reframe the term “equity compensation” and turn it into “compensation in the form of equity.”
This small distinction highlights a critical point. Equity in your company is first and foremost a form of compensation. It only turns into a long-term investment if it makes sense for your situation.
Companies award equity compensation to their employees for their own objectives. Most commonly, these objectives consist of recruiting new talent, retaining valuable employees, and meeting internal financial objectives.
As an employee receiving this compensation, you too have your own personal objectives.
- When you receive your normal paycheck every two weeks, what do you do with it?
- Do you pay your personal expenses?
- Do you invest for the long term?
- Do you spend some in the form of “fun money”?
Just like your paycheck, your equity compensation should be used to fund your financial goals and circumstances.
Think about it this way. If someone on the street handed you $500, what would you do with it? Would you buy shares of your company stock? The answer may be yes, but you would likely weigh all other options. While your employee stock compensation has a few more nuances than this simplified example, the mentality is the same.
Know the Details of Your Equity Compensation
Now that we have properly framed your equity compensation, you need to get clear on a few things.
- Types of Compensation: There are quite a few types of equity compensation. Here are the 4 most common in the tech world:
- Amount of Compensation: It’s important to understand how significant this compensation is relative to your entire financial picture. What percentage of your assets or net worth does it represent? Maybe it only accounts for 1% of your total assets. If that’s the case, you may just want to hold it as a long-term investment. On the flip side, what if it makes up 50% of your net worth? That fact changes the conversation altogether.
- Rules and Terms: Each type of compensation has a different set of rules and protocols. Most of them involve tax implications, buying/selling restrictions, and costs related to exercising your options.
You need to have a strategy that incorporates ALL forms of equity. Try not to keep the different types in “silos”.
Assuming X amount of total equity compensation, what percentage of that money would you like to go to various goals (in an ideal world)? Do you have high-interest loans you would like to pay down? Are you saving for a down payment on a house? Are you confident in the long-term prospects of your company and want to hold some stock for the long term?
Don't Forget Taxes & Rebalancing in Your Plan
If you want to understand just a couple of important points about employee stock compensation, you should most certainly be focusing on taxes and rebalancing.
Taxes and Equity
The moment you’ve all been waiting for: how taxes impact your equity comp. Let’s take a look at the tax ramifications of the most common equity types you’ll run across.
- ESPPs: These options allow you to buy company stock at a discount (often 5-15%). As soon as you make that purchase, the discount is taxed as ordinary W2 income (just like your normal paycheck). As an example, if your company is trading at $100 and you bought for $85, the $15 discount is taxed. From there, any gain on a sale over $100 is taxed at long or short-term capital gains rates (depending on the holding period).
- RSUs: Think of these more as a bonus. The company simply grants you shares of the company (no purchase necessary). When those granted shares vest (i.e., you are now able to sell the shares if you so choose), the entire amount is taxed as ordinary W2 income. Using the previous example, if you were granted 10 shares of your company trading at $100 per share on the vesting date (for a total of $1,000), the full amount is taxed. The same tax rules apply for any gain on a sale over $100.
- ISO & NSOs: Similar to ESPPs, these options allow you to purchase shares at a specified price, known as the exercise price. The company grants you shares with a specific exercise price that never changes. On the vesting date, you have the option to purchase shares at the exercise price (which may or may not be higher than the current market price). For example, you may be able to purchase the shares for $60 while the current market price is $100. The tax laws get more complicated for these types of options and there are some key differences between ISOs and NSOs from a tax standpoint. If you want to dig in on ISO tax treatment, check out our blog on ISO tax strategies.
Rebalancing Your Portfolio
This concept is far more straightforward than the tax implications of equity compensation. Put simply, it is necessary to diversify your investments. There is a lot of risk associated with a large investment in one company, and you need to ensure that the investment in your company stock fits your risk tolerance and profile.
If the company went under and your investments went to $0, what sort of impact would that have on you financially? If the answer is “a major impact!”, you need to seriously consider liquidating some of those investments.
While the tax considerations are vital, your ability to withstand risk is definitely higher on the list. Paying taxes on a gain is one thing. Not having a gain at all is a whole new ball game.
Find Confidence In Your Equity Compensation
At Rivermark Wealth, we specialize in working with clients with complex equity compensation. If you're unsure how to leverage this important asset to your best advantage, contact us today.
Let’s work together to properly frame your equity compensation, consolidate your strategy, and implement a plan that works for you long term.