Dec 12, 2019
What is an employee stock option plan?
It’s a plan where a firm will allow employees to buy shares of their company through their payroll, effectively taking some money off every single month off your paycheck, going directly to buy outstanding units of shares.
Generally, a company will float additional units for this purpose. They'll know how many staff are doing this. They will issue shares and then you get to buy them.
The neat thing for most employees, is that they normally have one of the following employee contribution plans:
- The employee gets a matching provision where the firm will match X percentage.
- The company will give you X many shares if you've been working for the company for X amount of time.
- The company will let you buy shares at a discount
- The firm will gift you some options.
All of those are potential possibilities when it comes to employee stock ownership plans and stock contribution plans. Clearly the benefit is that the employees are sharing in the company success, they have pride in ownership. There could potentially also be some tax savings.
For the employer, it be considered a recruiting tool. You're going to boost employee satisfaction because you're incentivizing employees. You're also giving every one of your employees the opportunity to be an owner.
Some companies have done wonderful marketing campaigns around this and it truly is something neat because everyone in the office or everyone at the firm becomes a shareholder. Now, this can exist in privately held companies that aren't publicly traded as well.
You could have a situation where it's a private company and a key employee is either getting stock options, getting a discount or is buying shares in the company on a quarterly, monthly or even weekly basis. This is quite common.
Generally, with respect to the publicly traded securities, you would have an account usually through a third-party discount, a custodian of some sort.
You would have your shares on a separate statement, and they would accumulate over time. There's usually going to be some sort of vesting period. There can be a vesting period or a period where you can't remove the shares, or you might have some limited availability to move the shares.
Generally, the shares themselves will then be able to be transferred out to an RRSP or to a TFSA. They'll typically allow you to purchase them in those accounts as well, especially if they're publicly traded securities. These shares are now yours, you own them, and your employee has contributed for you to buy these shares. It really moves the needle in someone’s portfolio and it's certainly something that most people should be taking advantage of.
Full Blog Article and Video on TFSA vs RRSPs (https://robtetrault.com/tfsa-vs-rrsp/)
The incentives are that you own shares, you're a shareholder and you see the shares on your statement. You then get to do something with them. You're an owner of the company, you participate in the dividends as well.
Full Blog Article and Video on Dividends vs Salary (https://robtetrault.com/dividends-vs-salary/)
Stock Options
An option is the right to buy a stock at a future date, at a pre-determined price. Most of the compensation now for the high-level CEOs and Executive Leadership from publicly traded companies, are a stock option package in addition to the salary. The salaries are quite high, and the stock option package can be worth a lot of money for these executives.
If you’re receiving options, then you have might have the concern of what to do with your options and you might be seeking answers to the following questions:
- How do I trade them?
- How do I execute on them?
Hypothetically, let’s say the options are for 10 bucks and the shares are currently at 20 bucks. Sometimes a firm will simply execute the trade for you. Effectively, the firm or company will give you the profit. In this case, that would be a $10 profit.
Since you're executing at $10 a share, which are currently worth $20, you’re effectively paying $10 to buy these shares if you immediately sell them in the market at $20. Some firms will sometimes allow this, and they will just transact that for you. If that’s the case, you don't need to execute and physically have the money to buy the shares.
Now, if you're doing it through non-traditional means, this would not be considered an option as you would need the cash to execute your options for those shares.
You’re converting your options to shares and now your shares are then going to be sold.
If you have options and there is no end date on them, meaning no maturity date on them, then there's no date where they effectively become worthless. Generally, you don't want to execute on those options. You want to keep them as options as long as you possibly can until the day you're willing to actually sell and execute on the shares, because the option is worth as much as the share. But the option also gives you the opportunity to pass if you want at some future point.
If you execute the shares today, you own those shares and you no longer have the right to pass on the opportunity to invest.
If you do have that option plan through work, something that you need to consider is whether you should be executing the opportunity on the option. If your firm offers an employee share purchase plan and they're either matching or they're giving you free shares, take advantage of it.
Figure out your cashflow situation, talk to your advisor and figure out the optimal way to build your wealth. Most of the time, these plans give you that opportunity.