Many companies issue stock options for their staff as employee compensation. When used properly, it can provide great rewards for employees based on the value of the company. An employee stock option plan offers employees the right to purchase a set number of shares from the company’s stock at a specific price, otherwise known as the grant price, strike price or exercise price.
Just so you know, the purchase of these stock options cannot be made immediately once the options are offered. It is usually done in installments over a few years. The options will have a vesting date and an expiration date.
To help you understand everything better, here is a list of terms that you should know about stock options:
- Issue date – the date the option is given to you
- Expiration date – the date by which you must exercise your options or they will expire
- Exercise date – the date you exercise your options
- Vesting date – the date you can exercise your options according to the terms of your employee stock option plan
- Grant price/exercise price/strike price – the specified price at which your employee stock option plan sets
- Market price – the current price of the stock
How does Employee Stock work?
With the terms clear, let us now talk about how the employee stock options work. As mentioned above, the corporate benefits for employees include financial compensation in the form of stock equity. Employee stock options, also called ESOs or ESOPs, are just one kind of compensation that a company can offer. There are many others that may include:
- Employee Stock Purchase Plans: These plans give employees the right to purchase company shares, usually at a discount.
- Phantom Stock: This pays a future cash bonus that is equal to the value of a defined number of shares. There is no legal transfer of share ownership under this kind of stock, although phantom stock may be convertible to actual shares if a defined trigger event occurs.
- Stock Appreciation Rights (SARs): SARs offer the right to an increase in the value of a designated number of shares, payable in cash or company stock.
- Restricted Stock Grants: These give employees the right to acquire or receive shares as soon as specific criteria are attained. This normally includes working in the company for a defined number of years or meeting performance targets.
The main idea behind the plans is to offer stakeholders and employees an equity incentive to build the company and share its growth and success. This means that offering equity to employees is beneficial not just for them, but also for the company.
For employees, the main benefits of any type of equity compensation plan are:
- Depending on the plan, it may offer the potential for tax savings upon the sale or disposal of the shares.
- It offers a tangible representation of how much they have contributed and what is its worth for the employer.
- It gives a sense of pride where the employees can feel motivated to be fully productive as they own a stake in the company.
- An opportunity to share the company’s success directly through stock holdings.
For employers, the main benefits of these stocks options are:
- Incentivizes employees to help the company grow and succeed because they can share in its success.
- Boosts employee job satisfaction and financial wellbeing by providing lucrative financial incentives.
- It is a key tool to recruit the best and the brightest in an increasingly integrated global economy where there is worldwide competition for top talent.
- May be used as a potential exit strategy for owners, in some instances.
Types of Options
There are two types of stock options that companies issue to their employees, including:
- NSOs or NQSOs – Non-Qualified Stock Options
- ISOs – Incentive Stock Options
Both of them are different as varying tax rules apply to each. A non-qualified employee stock option is where tax is most often withheld from the proceeds of the employee at the time they exercise their options. But this is not the case for incentive stock options.
Ensure that you and the employee have a copy of the document. The employee might also ask for your help to understand the document and how to use it. So offer to assist your employees get the right advice or help as needed. It is also important for the employees to know that there are a lot of factors that influence the decision of when to exercise the options and they should keep an eye on their financial circumstances before making any major decisions.
Stock options are a great thing both for employees and employers. They just need to know how to use them and get the most out of it. With this, you now know exactly how to benefit from stock options. Want to get deeper into the various kinds of shares and what makes them different from each other? Check out the next knowledge-based article here!