Stock options

Like the title says just got a job offer and one think new that I was offered is stock options. I'm not really sure how this works because I've never worked for a company that offered them before. Was wondering if someone can give me the "idiot's guide" version. It's a privately held company if it makes a difference.

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HeroPsycho

This is a weird thing. One the one hand, if the company is doing well, they can be valuable. However, on the other, it makes planning for retirement and what not difficult. Your salary plus these investments are tied closely to how well the company is doing. If however the company begins doing poorly, you could find yourself unemployed loaded with a bunch of worthless stock. You definitely need to carefully weigh this as you setup other investment and retirement accounts to ensure you're properly diversified.

Mrock4

Stock options allow an employer to offer employee's a chance to buy stock in the company at a reduced rate. It can be offered as an incentive to stay on, to lure good workers, and finally to make employees feel like they are a "part owner" of the company, and thus bring more quality work.

It should be noted that there is quite often a vesting period which limits how much you can buy per a set time period.

Private companies often define the price of the stock (the "strike") based on the internal value to the company, which is decided through a vote of the company directors.

There is some risk, but if it's a solid company it can be a good opportunity.

NightShade03

HeroPsycho wrote: »

This is a weird thing. One the one hand, if the company is doing well, they can be valuable. However, on the other, it makes planning for retirement and what not difficult. Your salary plus these investments are tied closely to how well the company is doing. If however the company begins doing poorly, you could find yourself unemployed loaded with a bunch of worthless stock. You definitely need to carefully weigh this as you setup other investment and retirement accounts to ensure you're properly diversified.

Fair point, however I don't have a retirement fund or and investments as I'm only 23 and haven't even gone done that road yet (and I'm quite a few years away from retirement lol).

In the offer letter they offered me 1500 in stock options. Does this mean I can buy up to 1500 in stock options or that I am being hired already owning the 1500?

keenon

Do it, I wish I had back in the late 90s before UPS went public..

HeroPsycho

NightShade03 wrote: »

Fair point, however I don't have a retirement fund or and investments as I'm only 23 and haven't even gone done that road yet (and I'm quite a few years away from retirement lol).

In the offer letter they offered me 1500 in stock options. Does this mean I can buy up to 1500 in stock options or that I am being hired already owning the 1500?

That was more to point out what is often overlooked about stock options.

As for being 23 and being a long ways away from retirement, don't think that way. The sooner you start saving for retirement, the better off you are provided that you pay off your high interest rate debts first. There's no way to make up for time to compound the money you put in. Read this for an eye opening comparison of scenarios.

I don't know much about the specifics about stock options though. Never had the opportunity to participate in something like that.

» The Compound Return Marathon: Which Retirement Strategy Will Win?

mikej412

NightShade03 wrote: »

It's a privately held company if it makes a difference.

Are they planning to go public any time soon?

Or do they just have stock so they can be a corporation and the owners can avoid personal liability for their company's actions.

Stock options usually mean you have an opportunity to buy a certain amount of stock (usually at a future date or dates) at a certain price (usually more than the current price) -- which motivates you to do what's good for the company's stock price.

Claymoore

I am not a fan of stock options as this can put too much of your compensation and retirement risk in one company. You are already depending on that company for your short-term monetary needs based on the paycheck that comes every couple of weeks. If the company craters you now lose both your paycheck and retirement money that was tied up in their stock. No investment - no matter how great - should be too large a percentage of your retirement because that is just too much risk.

I had stock options from Sprint back in 2002. Fortunately I skipped the stock purchase plan (we didn't have options yet) in 2001 becasue the WorldCom merger fell apart and the stock bombed about a week after they set the stike price. The stock was more reasonable the next year so I jumped into the pool. I did OK on the stock purchase plan where we were allowed to buy stock at a discount, but I would have been better off getting toilet paper instead of stock options as that would have been both softer and worth more.

I thought the strike price was set at $5, but when I investigated exercising my options the next year (after my division closed and I was laid off) I found out the strike price was really about $22. The stock was around $12 at the time, so I could exercise my option to buy shares at $22 or I could buy shares on the open market for $12 - my options were underwater and efectively worth -$10 per share. Plus, I would have had to borrow the money to buy them in the first place. I thought I was going to borrow money from the brokerage to buy the $5 options and pay some fee (basically an outrageous short-term interest rate for a quick loan) and then sell the stock for $12 and paying more brokerage fees. I wasn't going to make much, but when I found out the real strike price I wasn't going to make anything.

Many companies also match your 401k contributions with company stock rather than cash for tax purposes. Sometimes there is additional vesting time in order to sell the stock and divest your retirement holdings. If you are not fully vested or the company stock crashes, your retirement holdings are screwed as well. This happened to Enron employees who were not allowed to sell their 401k match stock until they were 50 years old. Not only did they all lose their jobs, they lost years of retirement savings matches that they will never be able to recover.

Stock options are nice if you can get them before an IPO or the strike price works in your favor, but I prefer to have my incentive pay in cold hard cash.

NightShade03

@HeroPsycho - I took on a load of debt coming out of school so I planned not to buy into any 401k or the like until 25 because I should have all my debt paid off by then. I do understand the importance of compounding though...I probably shouldn't have come off so one sided.

@Mike - I'm not sure of their intentions to go public any time soon. I do know that they have grown significantly over the last 3 years during the bad economy and that they are aggressively hiring/growing already this year. I will have to find out more about this I guess.

NightShade03

Claymoore wrote: »

Many companies also match your 401k contributions with company stock rather than cash for tax purposes.

Stock options are nice if you can get them before an IPO or the strike price works in your favor, but I prefer to have my incentive pay in cold hard cash.

I am purposely trying to not put all my eggs in one basket. They do offer a 3% match with increases of 1% yearly till 10%. I am going to start by putting some money in that 401k plan, put some toward the stock options, and put some toward an IRA that I just started. I think that will keep my retirement savings guarded against any one thing failing.

eMeS

These can be good and bad. We often call them "golden handcuffs".

Some companies award these to keep good people working for lower salaries based on a potential payoff if and when the company ever goes public.

Other companies use them as a type of incentive or bonus that's awarded from time to time.

Typically a company gives you the "option" to purchase a certain number of shares at a set price in the future. If the company is already publicly traded you can buy and sell the shares and pocket the difference between your option strike price and the current market price. If the market price of the stock is lower than your option strike price, then it makes very little sense to exercise the option. In that case you would let it expire worthless.

Only at one time in my career when I worked for a publicly traded company for a brief 6 month stint did I have stock options. It was a very good deal in that I was offered 3k shares at $10 below market price. Unfortunately I was only there for about 6 months, so I didn't make it to the options date, but with the strike price being lower than market price plus the significant appreciation, it would have been about a $60k payoff in that one year. This particular company was eventually bought by HP, and had I stayed I would have probably cleaned up. This company actually used to get bad ratings from stock analysts because they tended to give out way too many options. The reason that I left after such a short stint actually resulted in a much higher payoff.

YMMV on stock options...A good way to look at it is that you're gambling part of your compensation on the success of the company. Personally I always equated these and the equivalent in privately held companies as somewhat restrictive.

MS

HeroPsycho

NightShade03 wrote: »

@HeroPsycho - I took on a load of debt coming out of school so I planned not to buy into any 401k or the like until 25 because I should have all my debt paid off by then.

You might consider two exceptions for not putting any money in a 401k/IRA until the debts are paid off.

#1. If you're getting a match that's higher than the interest rate on your debts. I was in credit card debt a few years ago when I became eligible for 401k with an 80% match on the first 5% of my income. No brainer, I postponed some debt repayment to get the full match. I'm sitting here today with all credit cards paid off and a healthy 11K in my Rollover IRA from the 401k even after the market tanked.

#2. You are pretty darn certain you'll rapidly pay off debt in a few years. Remember, you get a once in a lifetime opportunity to put money in a 401k/IRA for that year. You would be better off in those situations to prolong debt repayment a bit to get money into say an IRA if it won't significantly prolong your debt repayment. You might take even up to a year longer to pay off your debt, but if that means you'll wind up with your debts paid off AND an extra 5-10K in your IRA, that's fine. That's what I'm doing now. My wife's car is not paid off yet with 10K remaining, but I still put 10K in my wife's and my IRA's last year and will also put 10K in this year, with the car being paid off this year as well instead of the car being paid off last year and no money into our IRA's for 2009. Roth IRA's are also good for this, as you can use them as a makeshift emergency fund without penalty so long as you don't withdraw earnings from your contributions.

Off topic a bit, but hope this helps.