When employees take advantage of stock options that are offered as a benefit, you are granting them the opportunity to purchase shares of your company at a predetermined and discounted price. Since the shares are often much less expensive than the share price that nonemployees must pay, stock options can be a valuable benefit for employees.
As an employer, you can work with your team to decide how many shares each individual employee is allowed to purchase as well as how long the vesting period will be. Remember that your employees must remain employed with your company for the entire duration of the vesting period before they stand a chance of receiving their grant in full.
From your perspective as an employer, vesting is essential because it can help you ensure that your employees remain loyal to your company for a certain period of time. This will prevent employees from taking ownership of the options granted to them far too soon because vesting periods help minimize employee turnover rates while protecting the equity of your firm.
However, certain arrangements, such as an acquisition, can expedite the vesting period. While they are rare, this is still something to familiarize yourself with and keep in the back of your mind. If employees end up being laid off prior to being vested, those employees could potentially lose their unvested stock options.
That said, stock options are very common in startups or businesses like them because companies of this nature have limited capital to pay their employees — stock options give companies the opportunity to offer employees a potentially valuable share of stock at a reasonable and appealing discount. Employees may accept a position for a lower-than-normal salary in exchange for stock options that have the propensity to promise a much bigger payday at a later time.
There are a number of positive aspects surrounding stock options, but what about drawbacks? For starters, you can end up minimizing your overall ownership of the company and reduce the amount of profit you will yield personally in the future.
Additionally, you will have far less equity to offer investors, meaning growing your business will be a far more difficult goal to reach. But that’s why stock options are optional.
As an employer, you should ensure that the outcome of offering the purchase of stocks to your team members is an expense you can afford in the future. Some employers will only offer stock options to a small number of employees until the ability to extend this offer to more employees is more feasible.
Know your options
When it comes to stock options, there are two kinds to choose from — incentive stock options and nonqualified stock options. The main differences between ISOs and NSOs come down to the differences in tax-related qualifications and requirements pertaining to your eligibility.
Let’s take a summarized glance at these two complex tax situations. While this information can be insightful, always ensure that you speak with a professional who is experienced, as they can help you understand the more intricate details of ISOs and NSOs.
- Accessible to full- or part-time employees only.
- Not immediately taxable.
- Taxable at the point of sale from employee to next holder.
- Subject to capital gains taxes and federal income taxes.
- Must be held by employee for no less than one year once purchased.
- Must be held by employee for no less than two years after option became available.
- Eligibility determined by board of directors.
- Time frame of 10 years for current employees.
- Time frame of 90 days once employee is no longer employed by the company.
- Available to anyone who is part of the company, not just employees:
- Independent contractors.
- Taxable by employers at the point of employees opting for the NSO.
- Taxed as income.
- Not taxed again at a later date.
How do team members exercise their right to stock options?
Cash payment — Employees can pay to exercise their options by paying with cash for any transaction fees and withholding taxes that are applicable to the situation.
Cashless exercise — Team members can use their current stock options to pay for the cost of other shares.
Cashless exercise/sale — Employers let employees exercise stock options by using the company stock that they already own to cover the exercise cost, at which point the employees will pocket the remaining cash or sell just enough shares to pay for everything that is due while holding on to the remaining shares. Remember that the employees will owe the cost of transaction fees and taxes.
Are stock options considered a business expense? The answer is yes, and as a result, companies that offer stock options must keep track of them via stock option expensing, which is the process of accounting for the value of share options distributed to employees within the profit and loss reporting, though they are not deductible for tax purposes.
Even so, stock options are a way by which employers can attract and retain employees. Stock options offer the potential to become a significant payday for your entire team. This is made possible when the stock price rises because everyone who holds a share of your company stands to make a profit.
As with any business-related decision, there are many more details and complexities to consider when it comes to stock options. Be sure to work closely with a financial professional while you consider whether offering stock options is a good idea for your business.