Selling Company Stock To Raise Cash

 Believe it or not, selling stocks require a strategy that is just as important and detailed as buying them. There are a few scenarios where selling your company stock to raise cash makes sense. It generally has little to do with market activity and a lot to do with your personal circumstances as a Millennial in tech.

As history proves, successful investing isn’t a matter of timing the market. It’s more about responding to changes in your life and your portfolio. For reasons beyond your control, you may find yourself in a position where you suddenly need to come up with cash. In an ideal world, you would have a cash reserve in a high yield savings account to meet urgent or unexpected expenses. 

Alternatively, the proceeds from selling shares of your company’s stock, acquired through equity compensation, can be a useful source of income as well. However, you must proceed with caution when selling company stock to raise cash.

If you’re considering selling your company shares, there are a few concepts and tax consequences you must know. To guide your decision making around this topic, I’ve put together some main points you should consider. 

Identify the best shares to sell

When you hold company shares you’ve received at varying prices and moments in time, it’s advantageous to clearly identify which shares are best to sell. This strategy is an investment accounting approach known as Specific Share Identification, where an investor’s objective is to optimize their tax treatment when selling company stock to raise cash. 

For instance, let’s say you’re awarded RSUs, and receive 1,000 shares that will vest over four years. Each year, the price per share, also known as your cost basis, is increased by $5. In this scenario, you’ll receive 250 shares at $10 per share in year one. In year two, you’ll receive 250 more shares for $15 per share. In years three and four, you’ll receive 250 shares, but at $20 and $25 per share, respectively.

As you can see, these shares will vest at different prices, and if you decide to hold them rather than selling immediately, they will have different holding periods. If an employee were to sell a portion of their company stock to raise cash, there would be different tax implications for each group of shares. Considering this, make sure to get clarification on how to indicate specific shares to sell through your brokerage firm (E-Trade, Vanguard, Fidelity, etc.).

Understand capital gains taxation

Capital gains are profits from the sale of a capital asset, such as shares of company stock. Notably, when you sell company stock, you will generate a capital gain or capital loss. The calculation is simple — it is the difference between the sales price and your cost basis. Once you’ve decided to sell your company stock to raise cash, the challenge becomes minimizing taxes on the income received. 

If you hold company stock for more than one year after exercising stock options, purchasing shares through an ESPP, or vesting of RSUs, it will qualify for long-term capital gains rates. If you hold the shares for less than a year, it will result in short-term capital gains rates.

The difference between the two is relatively simple. Short term rates are taxed as ordinary income, as high as 37%, while long term rates are capped at 20%. Because of this favorable tax treatment, you are incentivized to sell shares that will result in long-term capital gains as opposed to the alternative.

Know your holding period for ISOs and ESPPs

Capital gains taxation especially plays a role when dealing with ISOs and ESPPs. Holding company stock purchased in an ESPP for more than two years from the enrollment date and one year from the purchase date will lead to favorable tax treatment on the sale. In a like manner, holding shares exercised via ISOs for more than two years from the grant date and one year from the exercise date will lead to lower tax rates. 

On the other hand, selling the shares too quickly will result in a disqualifying disposition and will have different consequences for ESPPs and ISOs. To drive my initial point home further, this is another reason to carefully identify the shares you want to sell. 

Watch out for wash sales

A wash sale occurs when you sell a stock for a loss, and you also purchase a substantially identical stock within 30 days before or after the sale. You might be thinking, “why would I ever sell my stock for a loss?” Without getting into the weeds of tax planning, the IRS allows you to use capital losses to offset capital gains, resulting in a lower capital gains tax. In the investment world, this is called tax-lost harvesting.

Under wash sale rules, the loss and holding period are carried over to the new replacement shares. For example, let’s say you sold shares of company stock for a loss. Any RSU vesting, ESPP purchases, or option exercises can trigger the wash sale rules if they occur within 30 days of the sale. That is to say, your cost basis from the shares that were sold will be added to the cost basis of the new shares, resulting in a higher cost basis. 

Know your company’s post-termination rules for stock options 

For the most part, employees typically have 90 days to make a decision and exercise their vested stock options when they leave a company. If you can’t get together the necessary cash and plan for the tax implications for the exercise, you’re likely out of luck. All those vested stock options representing years of hard work will expire, and be rendered useless.

Some companies view this is as a serious burden that many Millennials in the startup world face when they leave a company. Thankfully, there are leaders like Pinterest, Coinbase, and Asana, who have extended post-termination exercise (PTE) windows that reflect their culture and gratitude to employees. 

P.s. I found a list of over 150 companies, all of which have extended PTE windows far more than the standard 90 days. I’ve only shared it in my weekly newsletter with The Equity Shop community 😜

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Deciding Between Salary and Equity

There was a pretty enlightening trend on Twitter a few days ago, where folks in tech were sharing and comparing their compensation. For me, it cemented the idea that compensation in the tech industry is highly situational. What an employer may offer in base salary, equity, bonuses, and other benefits, largely depend on the role being filled, and where the company and employee are located. There is no one size fits all. To say the least, company strategies for compensation can be far from simple. Considering this, most tech companies offer equity as part of the compensation package, but employees rarely understand the value or how it fits into their financial plan. If faced with the opportunity to negotiate a better offer, how do you decide between salary and equity?

Salary vs. Equity: What’s The Difference

The advantage of being paid a base salary is that its a fixed amount of income that you can expect and plan your future around. Alternatively, in the context of compensation and investment, equity represents ownership in the company in the form of stock. Generally, the return on equity is often linked to company growth and performance. The purpose of equity compensation from an employer’s perspective is threefold: to attract and retain talent, align incentives, and reduce cash spending. 

  • Attract and retain talent. When a company demonstrates or has good predictability to manifest financial success, employees are incentivized to work for the company in hopes of their equity being worth a substantial amount of money in the future. 
  • Align incentives. Startups are usually strapped for cash, but even companies that can afford to pay higher salaries may prefer to give employees equity. The idea is that employees will work harder to achieve financial success for the company and increase the future value of their equity. In this way, equity can align employee incentives with company interests. 
  • Reduce cash spending. By awarding equity, a company can often pay less in salary compensation to employees now, with the hope of rewarding them with equity later. The cash savings can then be allocated toward other investments or operating expenses.

Types of Equity Compensation

Both private and public companies offer equity compensation for myriad reasons. Equity compensation can be granted in many forms, each with unique characteristics, benefits, challenges, and importantly varying tax implications. These characteristics will impact your overall financial plan, so you’ll want to identify your specific equity compensation type to understand its benefits and potential challenges.

From my experience, most Pre-IPO startups offer equity in the form of incentive stock options and non-qualified stock options. On the other hand, most Post-IPO and mature companies grant equity in the form of Restricted Stock Units (RSUs) and Employee Stock Purchase Plans (ESPPs). Recently, I’ve seen a few companies offer cash as an alternative, RSUs, at-the-money stock options, and out-of-the-money stock options — and gives the employee the choice to select what best fits their needs. 

For instance, let’s say you have a low-risk tolerance, and you’re starting a family or planning a wedding, the cash alternative would likely be the best choice. But if you’re in a financial position to take on more risk, taking the RSUs or even a mix of RSUs and stock options is likely the best strategy. Though I haven’t seen it in many plans, it’s a fantastic opportunity to further align your equity with your financial plan, and I sure hope it becomes widely adopted.

With that said, if you’re deciding between salary and equity here are some things to keep in mind:

Can you maintain your lifestyle on a lower salary?

Although they’re not mutually exclusive, equity compensation often goes hand-in-hand with a below-market salary. It’s critical to know your minimum number. If you can reshuffle your priorities and costs, so your reduced salary doesn’t make a significant difference in your lifestyle and ultimately your goals, then you’ve mediated much of the pay cut. It’s worth noting that cutting down might be a bit more challenging to do if you live in a high-cost city like New York City or San Francisco, where living expenses can put a dent in your income. 

What does your four-year career plan look like?

Awards of equity compensation are almost always subject to a vesting schedule. Vesting simply means that an employee is required to wait a specific amount of time before gaining full rights to the shares in the equity grant. The most common vesting schedule I’ve seen is four years, on a monthly basis, with a one year cliff. In essence, this means that 25% of stock vests each year for the first four years of that employees’ time at the startup, in monthly or sometimes quarterly increments. Generally, if an employee resigns or is terminated immediately, they get no equity. If they stay for years, they’ll get most or all of it. In any event, be sure to keep your career plans in mind when deciding between salary and equity. 

How strongly do you believe in the company and its mission?

The main risk associated with equity compensation is that there is no guarantee that you’ll gain from your equity’s appreciation in value. Many variables can influence whether your equity stake will actually pay off. Is it worth it to sacrifice a portion of your salary for the potential at winning big in the future? You’ll have to put your VC hat on because the answer will come down to how optimistic you are in the company’s future. 

Negotiating Your Offer

Everyone wants to walk away from the negotiation table with the feeling like they’ve won. When deciding between salary and equity, the key is to win at the right things. After you’ve done your research, take some time to determine what matters to you.

For startups, cash is the most precious resource, and founders may welcome individual requests to trade salary for more equity. Assuming you are offered a market rate salary and equity, and your employer is willing to make some trade-offs, you will need a framework to help you judge how much equity makes sense.

Your strategy will depend on the stage of the company you plan to join.

For early-stage startups, you’ll want to find out the company’s current valuation as well as the amount of shares outstanding. If you divide the company’s valuation by the number of shares outstanding, you will derive at the price per share. You can then divide the amount of salary you’re willing to sacrifice by the price per share to determine the number of stock options you should receive.

For example, imagine you’re offered $100k to join a promising early-stage startup and choose to forgo $10,000 of your salary for more equity. Assuming the company can raise at a $5 million valuation and there are 1 million outstanding shares, the company can raise money at $5 per share, and you can receive 2,000 additional shares for your willingness to sacrifice $10,000 of your salary. 

For mid-stage Pre-IPO startups, the trade-off should be based on the number of shares an employee could purchase at the current stock option price. Let’s say an employee wanted to forgo $10,000 of salary for the opportunity to buy more shares, and the current option price was $2 — the company will likely advocate granting an additional 5,000 shares. 

As I mentioned beforehand, tax ramifications of equity can be far more complicated than salary earnings. Equity compensation can be quite convoluted — but with the appropriate resources and a viable strategy in place, you may be able to leverage your equity within your financial plan to meet your goals sooner than you know.

Year-End Planning For Stock Compensation

As tempting as it may be to take your foot off the gas pedal and enjoy the holiday season, year-end is a key time for financial and tax planning. For Millennials in tech, year-end planning for stock compensation should focus on both the big picture and the details. If you haven’t taken the time to update your plan, this should be a good reminder. Even if you have been proactive with updating your financial plan, it is still an excellent time to strategize and game plan for the upcoming year. Taking a few moments to plan smarter can help you take advantage of wealth-building opportunities and get you closer to accomplishing your goals.

Create a Year-End Stock Compensation Checklist

To build meaningful wealth is to be intentional with your time and resources. Believe me when I say that it will never happen incidentally. So, as part of your year-end planning for stock compensation, here are a few things you’ll want to take a look at:

  • holdings and grants of stock options, restricted stock/RSUs, and other company stock
  • exercises, vestings, and ESPP purchases in the current year
  • scheduled vestings for the upcoming year in addition to salary contributions assigned to ESPP purchases
  • expiration dates for any outstanding stock options and deadlines for option exercises
  • trading windows, blackouts, company ownership guidelines, and post-vest holding period requirements/opportunities
  • brokerage firm statements
  • expected new grants in the year ahead
  • any estimated salary withholding adjustments needed for the year ahead in the Form W-4

Know Your Inventory

Begin with the end in mind. With a keen focus on your life and financial goals, you can design your equity compensation strategy to support and achieve those goals. Start by taking inventory of your holdings, including RSUs, ESPPs, ISOs, NQSOs, and company stock holdings in taxable and retirement accounts. Identify your holdings and the cost basis of owned shares, and you can quickly identify which shares to sell to fund your goals. Not to mention, maintaining your inventory will also help manage the tax impact, avoid losing shares to expiration, and reduce the risk that is associated with holding company stock.

Subsequently, consider the likely length of time of employment with the company. The expected longevity helps determine the value of the equity offering. Review your employer stock award notices to determine potential outcomes in the event you decide to jump ship. For instance, the impact for stock options could range from forfeiture of all vested and unvested grants upon separation to retention of all grants to the original expiration date. For restricted stock and RSUs, the impact may range from forfeiture of unvested grants to continued vesting per the original schedule.

How Much Company Stock Is Too Much?

There truly is no one answer. Some financial experts recommend that no more than 10% of your portfolio should be invested in your company stock, while others may have a contrarian perspective and elect for a concentration strategy rather than diversify. 

Storytime: I once got into an “internet discussion” with someone who believed it is best to invest with your heart because it pays off. They noted that if you believe in your company enough to maintain your entire position, it contributes to something greater than your financial stability — your throughput. You innately work with more diligence because your financial freedom is aligned to company growth. While I don’t wholly disagree, I think an individual’s circumstance undoubtedly plays a role. If you’re a young 20-something with little responsibility (relatively speaking), earning a decent income from a tech pioneer, then sure, maybe a concentration strategy is a good idea for the short-term. But if you’re looking to build sustainable wealth, or perhaps planning for retirement, education, or any irrefutable goal, then diversification is likely the best path.

Here’s the bottom line: owning company stock may allow you to share in the financial success of your company. But it also carries the risk that their financial problems will become your financial problems. In the event your company falters, not only might your investments tumble, but you might also find yourself out of work concurrently. Be smart about the degree to which you’re willing to tie your finances to a single company, even if it’s likely to be the next rocket ship.

The Timing of Taxes & Income Shifting

Keep a schedule of vested and unvested shares and their expiration dates. Request your company’s open selling windows so you can exercise “in the money” options before expiration, if feasible. Unlike stock options, which trigger taxes when exercised, RSUs and restricted stock generally give you no control over the timing of your taxes. As a result, taxation occurs when the shares vest.

However, there are two exceptions to this general rule:

  1. Choosing to be taxed at grant, as opposed to at vesting, by making a Section 83(b) election.
  2. Having a particular type of restricted stock unit that lets you defer delivery of the shares.

When the shares vest, you own the stock outright and have taxable W-2 income, along with your other compensation income during the year. In that case, it might be a good idea to time and shift other income around this restricted stock/RSU income to avoid getting bumped up to a higher income tax rate, or triggering the Medicare surtax.

At any time when you are considering exercising stock options or selling stock at year-end, you want to understand your tax rates, trigger points, and any shortfall in withholding. In general, you want to:

  • Keep your annual income under the thresholds for higher tax rates.
  • Recognize income at times when your annual income and tax rates may be lower.

Since you can control the timing of stock sales and option exercises, and you know when restricted stock and RSUs will vest, multi-year planning is especially valuable as it pertains to equity compensation. Primarily, in your year-end planning for stock compensation, you are looking to identify methods to shift income between years so that you are paying less in taxes over your lifetime. Money you don’t have to pay in taxes is money you can invest or spend, responsibly of course.

It’s All About You

Although it’s an important consideration, taxes should never be the only reason for exercising options or selling vested shares — or waiting to do so at year-end. Consider your investment objectives and expectations for stock price performance, but more importantly, your personal goals. How can you use equity compensation to UX design your financial life? If money were not an issue, what would you want your life to look like? What do you want to be? Whether it involves embarking on a business venture or settling down to start a family, the combination of your goals and well-designed equity compensation strategy have the power to change your life.