William Wong Feb 2018
stocks
How to Argue for and Against Them
Offer packages are becoming increasingly complex in today's War for Talent. Many corporations are utilizing equity based compensation as a carrot to woo, motivate and retain their employees. This article will arm you with the knowledge of these equity incentive instruments so you may guide your candidate into making the correct choice - your offer.
They come in the form of Stock Options (ISOs and NSOs), Restricted Stocks, Restricted Stock Units (RSU), Phantom Stock, Stock Appreciation Rights (SARs) and Employee Stock Purchase Plans (ESPP). We will cover three of the most popular choices you'll encounter in comp packages and how they compare to one another.
RESTRICTED STOCK UNITS (RSUs)
They're free and nearly always worth something, even if the stock price drops dramatically.
Introduction
These stocks are given to you for free after you meet a certain condition (a.k.a. restriction). These restrictions can be performance milestones or simply just by staying with the company for a certain length of time. RSUs are basically IOUs from the company to you - meet whatever criteria that was agreed upon and it's all yours. The beauty of RSU is even if the price drops significantly by the time you are vested, it's still worth something. You cannot go "underwater" like that of Stock Options.
They come in play for the following reasons:
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Startups are often tight on cash and can't compete with the big boys in the salary department. To combat this, they lure folks in with stocks to make up the gap between wage offered and market rate.
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They help retain employees - people aren't going to jump ship until they're vested (hopefully). This buys corporations more time and patience thru the rough patches that startups inevitably face.
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Stocks can motivate employees because, hey, who wouldn't work harder knowing they have skin in the game. Startups typically march with a united front because of this equity play.
A Peek Inside
Out of all the equity based compensations, RSUs are the simplest to understand and dissect. First, determine if your RSU is based on performance milestone or a vesting period. That's it. Only other thing to worry about is what Uncle Sam will take from you.
[1] Vesting Period
This is basically how long you have to wait before the company awards you the stocks. These are typically spread across several years, with each year earning you a certain percentage. Important note to make is there are many vesting schedules. When you go into a RSUs Scenario, make sure you figure out this important piece of intel.
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Graded schedule - the concept here is your RSUs spans over several years, with each year receiving the same %. For example, you are granted 10k RSUs over a 4 year span, with 25% (2,500 shares) vesting every year.
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Varying Interval Graded Schedule - this is a tricky one so pay attention. It is similar to a Graded Schedule, except it years and % are not evenly split. For example, you are granted 10k RSU. 25% is vested after 1 year, and remainder is vested every month for the next two years. Or, they could say, 10k RSUs, 5% after year 1, 15% after year 2, 40% after year 3 and 40% after year 4.
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Cliff schedule - it's like falling over a cliff - as in, once you cross a certain period of time, you get it all. Example: you are granted 10k RSUs and are granted 100% of the stocks after 3 years.
[2] Tax Implications
They are taxed when you receive the shares. Your taxable income is the market value of the shares at vesting. You will be taxed again if you experience capital gain when you sell your shares.
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You are granted 10k shares that vests 25% each year (2500 shares/yr).
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The stock price at vesting in year 1 is $10, which means you will have $25k added as ordinary income (25k shares * $10/share).
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The stock price at vesting in year 2 is $20, which means you will have $50k added as ordinary income (25k shares * $20/share).
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The stock price at vesting in year 3 is $30, which means you will have $75k added as ordinary income (25k shares *30/share).
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The stock price at vesting in year 4 is $40, which means you will have $100k added as ordinary income (25k shares * $40/share).
Let's say you hold on to all your stocks and sold it later for $50/share (10k shares * 50/share = 500k). Since you already paid $250k in taxes when you were granted the shares (25k + 50k + 75k + 100k), you will only have to pay $250k in capital gains tax ($500k-$250k).
[!] How to argue Against them
You will have to look at the risk tolerance of your candidate and other factors to craft up your defense.
Stock Options
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If your offer has Stock Options w/ a reasonable package (base + bonus) and candidate is a risk taker, then sell the dream. You're definitely not going to get filthy rich by exercising RSUs compared to Stock Options. If the candidate is able to sustain a decent lifestyle with the bare package, and they truly believe in the company, then stock options are the way to go.
Salary Heavy
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Alternatively, if your package is Salary heavy, then educate your candidates about Portfolio Diversification; they should never put too much money into a single investment (especially stocks). As an employee, you're already putting a large chunk of your income stream (salary) into the hands of your employer. Having RSUs in that same employer magnifies the risk factor. Imagine if something were to go wrong with that employer (say a bad lawsuit or an under performing business) which results in you getting laid off and their stocks plummeting. This scenario basically have you losing your main revenue stream + all your nest eggs (think Enron/Worldcom - how employees lost their jobs + live savings because they have so much stocks invested in the company).
ESPPs
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Your defense here is very similar to the Salary focused approach in terms of Portfolio Diversification, except you will pitch an ESPP as a very stable investment as long as you sell at every Purchase Period. See the section on ESPP to learn about calculations, but the average Discount Rate for ESPP is 15%, which will give a guarantee minimum return of 18%. If you're looking at the rate of return of how long your money was locked up, that ROI actually goes up to 91.6%. Regardless of how you calculate your ROI (91.6% or 18%), that type of return is extremely hard to beat even in a bull market. If i could, i would dump all my money into ESPP every... single... day, and twice on Sundays.
