In the startup world, it’s no anomaly for companies to offer stock compensation as a means of attracting, motivating, and retaining employees. For those Millennials in tech fortunate enough to be provided equity, the rewards can be a significant wealth-building opportunity. Receiving stock options or other common types of equity compensation can feel like a windfall, but real happiness and success begins with discussions centered around how equity compensation can play a role in your financial life, alongside your values and goals. This sort of financial life planning is what I like to call a holistic approach to managing stock compensation.
Know Your Why
Money and wealth themselves are certainly not the end goal; they’re simply tools that provide the means to your goals. While accumulating wealth can improve your quality of life, there is more to stock compensation than becoming financially well. When you know your why, your efforts point toward something of higher value. What truly matters is what you do with that wealth and how you fit it into funding your personal life goals. When your purpose drives the process, it’s much easier to stay focused on the journey.
Using Equity Compensation to Fund Your Goals
When you receive a stock grant or acquire employer company stock, you gain an ownership interest in the company. Whether you participate in an ESPP or have grants of stock options or RSUs, when your company’s stock price increases your wealth increases, and perhaps substantially.
If you’re looking for a holistic approach to managing your stock compensation, therein lies financial planning. Real financial planning should start with identifying goals. What do you want to do with the proceeds from the eventual sale of the stock? Understand what you want and need out of life – and the role equity compensation can play in building your wealth toward those life goals. For many Millennials in tech, that could look like starting a business, creating a nest egg for your heirs, providing meaningful experiences for yourself and your family, and the list goes on.
Managing your stock compensation meshes with the many moving pieces of your financial life. These areas may include cash-flow needs, retirement security, income taxes, investment strategy, estate planning, and job tenure, along with company and legal requirements (i.e., lockup periods).
Understand What You Own
There are different forms of equity compensation, so it’s crucial to know what you own. Stock options give you the option to buy company shares at the exercise price, while RSU’s involve a direct transfer of shares to grant recipients.
The intricacies of equity compensation taxation can easily catch the smartest, most organized person by surprise, so it’s essential to determine how you will handle them over time. Some factors that can affect your tax bill include:
- Whether you have ISOs, NSOs, or RSUs
- How long you’ve held the stock
- Your income bracket
- The price when you bought the stock and how much they’re worth when you sell them (if they were options)
- State of residency
Remain aware of your choices, the term of your options, vesting rules, and the tax and lost-gains consequences of your exercise decisions. Once you’ve figured out how your equity compensation works and how it will be taxed, you can then decide what it’s worth.
It’s natural to be excited about the value of your company — after all, you work there for a reason! Considering human nature, it’s not uncommon for employees to be overconfident in their estimates of their company’s performance. “But what if I work for a tech giant or unicorn?” I hate to break it to you, but even the top dogs can fall victim to a market decline or some other unforeseen event when you need the money.
Having an ownership interest in any company means that you’re taking on the potential risks and rewards of being a shareholder. By owning company stock, you’re subject to both general market risk and company-specific risk (i.e., significant drop in share prices due to weak quarterly earnings report). It’s essential to be aware of the risk of overexposure when managing company equity.
An advantageous approach to reducing the risk of concentrated positions is to sell the stock and diversify it into other investments. That doesn’t mean you have to sell all the stock and it certainly doesn’t have to happen right away. You might want to diversify over the course of a few years, and you’ll want to do it in the most tax-efficient way. Along with a trusted financial planner, you’ll also want to add a knowledgable tax professional to your arsenal. Trust me, this is a decision you won’t regret.