Stock options are a common part of a compensation package in some industries. This is especially true with startup companies.
They are a great way for employers to align their employees’ interests with the best interests of the company. It's also a way to expand your investing efforts.
If you have stock options, leaving a company can be a bit more complicated than a typical break up with your job.
When you leave, your stock options will often expire within 90 days of leaving the company. If you don’t exercise your options, you could lose them.
Here’s what you need to know about stock options and what you should do with them when leaving a job.
Basic Overview of Stock Options
A stock option gives you the option to buy a share of stock in the future at a set price.
When you decide you’re ready to buy the stock using an option, you exercise the option. When you exercise your option, you pay the cash price stated in the option contract and receive stock.
This can be beneficial if the cost to exercise your option is below the stock's market value.
This is often the case and is why some companies include stock options as part of a compensation package.
If you decide not to exercise your stock options, for whatever reason, they expire at the end of their life.
Stock option expiration
The life of an option can vary depending on the type of stock options you hold but generally, they last up to 10 years.
Stock options may expire due to other reasons, too. Many stock options expire shortly after leaving a company.
The typical expiration period is 90 days.
The period can vary and may be shorter depending on your particular options.
In some cases, options can expire immediately upon termination if you're terminated for cause or decide to work for a competitor.
You may not be able to exercise your stock options right away, either. Many stock options are earned over a period of a few years, called vesting.
For example, a vesting schedule may allow you to earn your options over a four year period. In this case, you may earn 25% of the total number of options after you complete each year of service.
In this example, you’d vest in 25% of your options after you complete one year working for your employer. Eventually, you'd vest in 100% of your options after you complete four years of service.
Make Sure You Understand Any Stock Options You May Have
It’s important to understand how your stock options work if they're part of your compensation.
There is plenty of general information about stock options available to read. That said, you need to make sure you understand the specifics of your options.
You’ll want to make sure you have a copy of two documents:
- The plan document
- Your personal stock option grant document
The plan document explains how the overall stock option plan works for the company.
The personal stock option grant document details your specific option benefit.
In particular, make sure you understand the following aspects of your stock option plan:
- How many options you’ve been granted
- The price at which you can exercise your options
- The vesting schedule of your options
- How you can exercise your options
- How and when options may expire
- How you may be able to earn more options
- If your stock options can be revoked by any actions, such as working for a competitor
Public Company Stock Options
Stock options for publicly traded companies are much easier to value than stock options for private companies.
All you have to do is look up the current stock value.
Look to see if the cost to exercise your option is less than the current stock price. If it is, you’re what’s considered “in the money”.
It usually doesn’t make sense to let your stock options expire if they’re “in the money” unless you’re restricted from selling stock. Sometimes this may happen due to SEC rules, such as insider trading rules.
If you’re hurting to scrape together enough money to exercise your options, you could borrow money to purchase your options. Then, immediately sell the shares.
Finally, use the proceeds to pay off the loan and bank the profit. Of course, you may owe taxes on that profit, too.
If your options aren’t “in the money”, it wouldn’t make much sense to exercise them. After all, you'd be paying more for your stock than it’s currently worth.
Private Company Stock Options
Private company stock options could result in a huge payday or a major loss depending on the company’s success.
It may be hard to figure the true value of the stock you may buy since it isn’t publicly traded.
Companies may have the stock valued by professionals or may base the current value on the latest round of investment made in the company.
If you buy stock using your stock options with a private company, it may be difficult to sell the stock you own.
Most private companies have strict rules over who can buy and sell their stock if you can sell it at all.
Instead, many people end up selling stock in private companies when the company’s stock goes public, also called an initial public offering (IPO), or when the company offers a buyback period where they repurchase shares.
After an IPO, there are usually no longer major restrictions on buying or selling stock in most cases.
However, employees that hold a significant percentage of the company’s stock or that have access to insider information may be subject to other rules by the SEC.
Companies may offer share buybacks before the company goes public. This allows longtime employees to cash out some of their paper wealth.
Without buybacks or an IPO, they may not be able to access that wealth any other way if they can't sell the stock to others.
While stock buybacks and IPOs allow employees to cash out in a successful company, not all private companies succeed.
Instead, many companies end up bankrupt. In these cases, the shares of stock employees purchased usually become worthless.
While this is a risk, most newer companies set exercise prices for stock options relatively low. That way you don’t stand to lose as much if a company goes bankrupt but you stand to gain a lot if the company succeeds.
Decide Whether to Exercise Your Options
Deciding whether to exercise your options when you leave a job is a personal decision.
If you’ve left your company on your own terms, hopefully, you have enough money set aside to exercise any “in the money” options before they expire.
If you were fired
Unfortunately, people don’t always leave on their own terms. If you’ve been terminated, you may be in a financial bind.
Sadly, if you don’t have money for day-to-day expenses you may not be able to exercise your options before they expire.
This is even more of a problem if the options are for a private company's stock which you cannot sell immediately.
The company's future
Either way, you need to take a serious look at the financial health of your company. You should evaluate the chance that it will continue succeeding, too.
Answering these questions should help you determine whether you think owning the company's stock is a good idea.
Even if you do decide that the company’s future is bright, don’t tie up all your money in one company’s stock.
If you do and something awful happens, you could lose your entire investment very quickly. The risk is even greater if you can’t sell shares whenever you please.
Instead, you can diversify your risk by keeping your old company's stock holdings to just a percentage of your overall investments.
If your old company’s stock decreases, you’ll still have other investments to offset the potential loss.
Don’t Forget About Potential Tax Impacts
Exercising stock options and selling stock you purchased from a stock option has tax consequences.
Of course, the consequences depend on your particular situation. It’s important you understand what impacts these actions can have on your personal financial situation.
Doing so before you make any transactions allows you to plan ahead and make the best possible choices.
If you aren’t sure what will happen, you should talk with a Certified Public Accountant (CPA), tax preparer or financial advisor.
These professionals should be able to understand the documents that govern your stock options. The professionals can then advise you of the potential tax impact of exercising your options.
It’s Your Decision
Ultimately, it’s up to you whether you want to exercise your stock options.
Keep in mind, you can exercise them before or after leaving your employer in most cases. You just have to follow the rules of your plan.
If you decide to exercise the stock options, make sure you understand how they work. If you do this before you turn in your notice to leave the company, you keep your potential choices open.
Understanding your choices before you make a decision allows you to make sure you are in the best position to take advantage of any stock options you may have available.
If it is your decision to leave, you can even wait until you fully vest before putting in your notice. This could allow you to access every stock option available to you.