Have you ever ignored doing something you knew that you should do? What “something” immediately came to mind when I asked that question?
Its OK. We all do it. Maybe that something you’re ignoring is uncomfortable to face, maybe it’s boring, maybe you don’t fully understand what it is you must do or maybe you just plain don’t want to spend the time on it.
In my experience one of these “somethings” is establishing a process for how to handle company stock compensation.
That’s unusual, because company stock compensation can be one of the most valuable pieces of compensation you receive for your hard work. Handled properly, it can be a powerful wealth building tool.
I think people often ignore it because they don’t fully understand how it works. Company stock is “something” to deal with in the future when our shares vest or when someone buys the company.
A simple process can set you on the right path for utilizing and valuing your company shares. Three steps is all you need to follow to turn this “I’ll get to it” into an “I got it done!”
Step 1: Understand Your Company Stock Compensation and its Value
First and foremost, it is essential to understand what-in-the-heck your personal company stock compensation is. There are several forms, and your compensation package may include one or more types of stock compensation. If you aren’t already familiar with the types, check out this guide that covers the ABC (and D’s) of equity compensation.
A basic understanding of your stock compensation: the advantages, how they are taxed, and what decisions you will need to make, helps establish the framework for properly addressing your responsibilities.
This is a good time to consider the value gained from company stock as part of your overall compensation package. When a company offers you shares of ownership, they are giving you an incentive to not only stay with the firm, but also reap the rewards of the value you are adding to the company. That value you add can then have a powerful impact on your own financial situation. Give this benefit the respect it deserves.
When evaluating your position, stock compensation should be factored into your decision. If you are not offered stock compensation, you might negotiate a higher cash salary and bonus to make up for the lack of longer-term incentives. Alternatively, you may be willing to accept lower cash compensation in exchange for the opportunity to own more company shares if you believe in the company’s mission and future. Allow me to offer an example:
Before launching my own practice, I worked for a startup digital wealth management company. When I joined the startup, I took a significant pay cut from working at a behemoth bank, but also received Incentive Stock Options (aka ISOs) in the startup company. Even as the startup grew, the cash compensation was still lower than I would have received working at my old job, which was fine because I kept receiving more grants of ISOs. Eventually, the startup was acquired by a large firm and those ISO shares paid off.
Considering that stock compensation usually comes with an ongoing vesting schedule, you also need to consider how long you plan to work for the company. If you only plan to be there for a year or two, there may not be as much benefit to company stock. You might want to avoid getting “handcuffed” to a job you are miserable at. I worked at the startup for seven years before a liquidity event (my first opportunity sell my shares) came along! As valuable as company stock is, life is too short to hate your job and feel stuck while you wait for shares to come your way.
Step 2: Concentrate on how much exposure you are OK with
It is good practice to periodically summarize your entire financial life in one picture, even if you don’t have company stock compensation. The easiest way to do this is to make a list of all your assets and liabilities that when added together determine your net worth. This is also known as your balance sheet.
On the asset side, consider all your cash, investment, and retirement accounts, as well as personal property like your home. For the liabilities, think of any debts that you owe, such as a mortgage, auto loan, student loans, or credit cards. Then subtract the total liabilities from your total assets to find your net worth. This snapshot tells you where you stand today and establish a baseline for future decisions, including how to handle company stock compensation.
One of the biggest risks that comes with accumulating company stock is significant concentration. That simply means the amount of company stock you own makes up a large percentage of your total assets. Concentration can be risky if the value of your company were to decline significantly. Remember your paychecks come from the same company. In a worst-case scenario, the value of your stock is declining and your job is in jeopardy due to poor company performance…a situation everyone wants to avoid!
To evaluate how concentrated you are in your company stock, simply divide the value of your stock by your total assets. It is common to exclude the value of real property, such as a home, and only factor in your liquid assets, like cash, investment, and retirement accounts. For example, imagine that your company stock is valued at $250,000 and the total value of your cash and investment accounts (including that company stock position) is $1,000,000. Your company stock then represents 25% of liquid net worth. That’s a significant concentration!
You should also consider a second calculation that factors in any unvested shares you have coming your way in the future. While the unvested shares aren’t yours quite yet, and it’s more difficult to pinpoint what they will be worth in the future, they should be taken into consideration. Looking at the value of your unvested shares helps you understand what the concentration may grow to if no action is taken.
Continuing our example, assume that the $250,000 in vested shares is only half of what you will eventually receive in total. Over the next few years, additional shares will vest to that are currently worth an additional $250,000. That means you have exposure to $500,000 worth of company stock. That quickly amounts to 40% of a total liquid net worth of $1,250,000. If you fail to diversify the shares, your net worth will be tied closely to the performance of your company stock. That benefits you if the stock grows and does well, but could be disastrous if the stock price takes a dive. As the wise adage goes, concentration can build wealth and diversification helps you to keep it.
There is no right or wrong answer to how much company stock you should hold. A lot of it comes down to personal preference. A good rule of thumb is to not hold more than 5-10% of your liquid net worth in one position.
If you believe in the prospects of the company and want to hold some of the shares you have, there is nothing wrong with doing so. Just make sure you know how much exposure you are willing to have, considering both vested and unvested shares. Then use that maximum exposure amount to guide your decisions on diversifying the shares. If you decide that the largest concentration you are comfortable with is 10%, then be disciplined about diversifying shares when your vested shares reach that threshold.
Step 3: Diversify with Discipline and Intention
The final step is to make a plan for diversifying shares and what you will do with proceeds. With a plan in place, its simply a matter of continually repeating that process when shares vest or your concentration rises above the threshold you feel comfortable with. Failing to have a plan in place is what leads to company stock becoming that “something” we put off dealing with.
A natural place to start is creating a schedule based on when shares vest to you. If shares vest on an annual, quarterly or monthly basis, you could review your positions on the same cadence. This takes time and discipline. Many people benefit from working with a financial advisor to hold them accountable or remind them when it is time to review things.
Beyond simply selling based on a schedule, you may want to plan for which shares you will sell. You might prefer to place a larger emphasis on the tax implications of selling shares that have vested at different times by trying to target those shares that are considered long term instead of short term. At times you may even hold shares at an unrealized loss, which can be more efficient to sell from a tax perspective.
While it is important to know and consider the tax consequences of selling shares, we also don’t want to let the tax tail wag the dog. Taxes are an important consideration, but shouldn’t be the primary driver in your decision making. If you allow a concentration to form because you are trying to wait for your shares to reach long term status, you might incidentally expose yourself to more risk than you are comfortable with.
As you diversify the shares, you should also have a plan for what you are going to do with the proceeds each time. I suggest refreshing and revisiting your financial snapshot each time you sell shares. Ask yourself:
Do I have an adequate emergency fund of cash?
Are there any larger, one-time expenses I anticipate in the next 12 months that I may want to hold additional cash for?
Do I have any high interest rate debts, such as credit cards, that I should pay down aggressively?
If you review those questions and find that you do have enough cash and your high interest rate debts are paid off, then you should consider a longer-term approach by investing the proceeds in a diversified portfolio. By investing the proceeds, you benefit in two primary ways. First, you diversify some of the risk that comes from only investing in your company stock. Second, the longer time you are invested, the more you reap the rewards of compound interest.
By implementing a process for diversification and knowing what areas of your financial life to zero in on, you will feel more in control of your company stock compensation and better positioned to make the most of this powerful benefit.
And that is “something” we can all feel good about.
Hello! I am Danny Kellogg, an LPL Financial Advisor with Prosperion Financial Advisors. The best part about my job is using my experience and education to help clients discover how their financial resources can serve them. To deepen my knowledge and demonstrate my dedication to serving clients at the highest level, I became a CERTIFIED FINANCIAL PLANNER® and Retirement Income Certified Professional®. My wife Elizabeth and I are both proud Colorado natives. We live in Centennial, CO with our daughter Libby and golden retriever Aggie. I am an avid Colorado sports fan who enjoys cheering on the Rockies, Broncos, Avalanche, Nuggets and Colorado State University Rams. When I am not helping clients, I enjoy spending time with my family and playing golf.
It has been a year for humility as many of the traditional methods of managing risk inside portfolios have been taxed. It has been a year of consciously focusing on gratitude for all that we have and all that has gone well. It also has been a year where the value of our disciplined commitment to planning has never been more highlighted.