Congratulations! You’ve been awarded incentive stock options in
This may be the most amount of money you’ve seen in your
lifetime. As such, you would be best served developing a solid
written game plan for managing your “winning hand.” Don’t fail to
plan with a financial decision of this magnitude.
I’ve seen dozens of stock incentive plans for companies — both
private and public. The most common form of stock based
compensation offered by privately held companies to its employees
are incentive stock options or ISOs.
Typically, new full-time employees are granted a number of shares
of stock on their date of hire based on the current market value
per share. The first page of the agreement often specifies the
- Name of optionholder: This is you, the
employee. The legal owner of the options.
- Date of grant: The date you were given the
- Number of option shares: The total number of
shares you were given.
- Exercise price (per share): This is also
called the “grant price” or “strike price.” This is the price
you will pay for each of the shares you were given, even if the
actual stock price is higher the day you cash in.
- Vesting start date: The date your shares begin
to vest. When your shares are “fully vested,” they are fully
- Type of options: The two most common kinds of
stock options are incentive stock options (ISOs) and
nonqualified stock options (NSOs).
- Vesting schedule: The amount of time you’re on
the hook before all of the shares are fully yours. In some
cases vesting is associated with meeting specific performance
Once you’ve been with the company long enough — usually 4 to 5
years — your stock options will be 100% vested, meaning you can
cash in when you’re ready. By then, the shares hopefully will
have appreciated in value so you have what are called “unrealized
gains” in your company’s shares.
You may be wondering what you should you do next. Many people
start with the tax implications, but letting the tax tail wag the
dog without considering other critical factors can be a
catastrophic financial mistake.
Below is the game plan I put together for my clients
when stock compensation makes up a meaningful percentage of
their net worth. This five-step plan should help you avoid some
of the common pitfalls affecting investors:
1. Quantify your goals.
For example: You’re planning to purchase an apartment in San
Francisco for $1 million. You’ll need around $200k stashed away
for a conventional 20% down, 30 yr. fixed mortgage.
Colleagues at your company may discourage you from selling
shares. They’ll tell you, “Don’t sell now, you’re foregoing
tremendous upside.” Don’t listen to them. For every Facebook and
Google there are
hot tech IPO duds like: On Deck Capital, Coupons.com, GoPro,
Fitbit, to name a few. Stick to your plan and do what makes you
comfortable. We all have different goals and risk tolerances.
2. Set aside 3-6 months of living expenses for a rainy day fund.
If you don’t already have one established, use a portion of the
proceeds from exercising and selling your stock options for a
rainy day fund.
Life gets in the way. Having a rainy day fund affords you
flexibility. Whether you decide to take time off, or perhaps are
considering a career change, having this fund will give you the
financial freedom not to have to take the first available job.
3. Don’t ask everyone in your network for advice.
Your accountant, colleagues on your team, wealth advisers,
friends, family: Everyone you know will each have different
suggestions based on their training, background, relationship
with money and inherent biases. YOU know YOU best!
4. Find an accountant well versed in the taxation of stock
According to Walt Medling, a certified public
accountant at Bay Area Tax Group, there are three kinds of taxes
you should consider when exercising your incentive stock options:
ordinary income tax, long-term capital gains tax, and the
alternative minimum tax (AMT).
Long-term capital gains are preferable, but only attainable if
stock is held for at least two years from grant date and one year
from exercise date. And it’s important to be aware that income is
often recognized for AMT purposes at the time you exercise
options, long before you may be selling stock and putting cash in
Proactive planning with an expert can significantly help with
cash flow management, projecting future tax obligations, and
maximizing your tax saving opportunities.
5. And finally, diversify.
When you exercise and eventually sell your incentive stock
options, you’ll be presented with a new issue: what to do with
the cash in your brokerage account. Not to worry. There are a
number of options available to you, depending on your financial
advisery needs. You can work with a robo-adviser, the most
well-known to the millennial generation being Betterment and
Robo-advisers provide a low-cost automated model investment
portfolio of passive exchanged traded funds (ETFs) based on
results obtained from their questionnaires. And if you happen to
be investing more than $5,000, you may consider Schwab’s
robo-advisery offering, Schwab Intelligent Portfolios, which charges
no advisery fee, account services fee or commissions.
If, however, you decide that when it comes to your financial
well-being, you’d prefer a relationship with a human financial
adviser who can cover anything from stock options to
budgeting to collaborating with your accountant, attorney,
and more, be sure that the adviser you decide to work with is a
fiduciary, and therefore legally required to
put your best interests first.
Aaron Hattenbach, AIF® is the founder and managing member of
Financial, a registered investment advisery firm
headquartered in San Francisco, CA. Rapport Financial specializes
in advising technology professionals at public and private
companies with stock based compensation.