To retain talent in a competitive job market, many companies must get innovative in the ways that they compensate their employees. Salary, health benefits, and pensions are all ways that businesses have traditionally made themselves attractive to top talent. Employee Stock Options are another, less common, form of employee incentive that can be a way to bridge the gap between management and employees to encourage them to strive for the company’s success.
Employee stock options are granted to employees by their employer to allow them to benefit from the growth of the company. The stock options allow you buy a certain number of shares at a predetermined price within a certain period of time. The idea is that at the time you exercise your options, the market price of the stock is higher than your predetermined purchase price, resulting in an immediate profit while still allowing you to hold the stock and benefit for future growth.
There are some key terms when talking about stock options:
- Issue Date: The date that you are granted the stock options.
- Strike Price: The pre-determined share price that at which you can purchase the stock.
- Market Price: The current value of the stock.
- Vesting Date: The date that you can exercise your options.
- Expiration Date: The date that you must exercise your options by before they expire.
For example, let’s suppose that on January 1, 2017, you were granted the option to buy 1000 shares of company stock for $10 a share. You must exercise the stock options by January 1, 2025. On March 1, 2022, the market price of the company’s stock is $30 per share. This is called being in the money, as the share price is higher than the strike price. You decide to exercise your stock options:
- Your issue date is January 1, 2017
- Your exercise date is March 1, 2022
- The market price is $30
- The strike price is $10
- The expiration date is Jan 1, 2025
To exercise you must buy the shares for $10,000 ($10 x 1000 shares). You would then own 1000 shares valued at $30 a share.
If you decide to exercise your option and buy the securities at less than the market price, you will have a taxable benefit. The taxable benefit is generally the difference between what you paid for the securities and the market value at the time you exercised your option. In the example above, there would be a $20,000 taxable benefit to the employee. The strike price was $10, and the market value was $30 at the time of purchase (($30-$10) x1000=$20,000)
You can reduce the amount of the benefit by any amount you paid to acquire the option rights. (Canada Revenue Agency, 2021)
Employee stock options can be of great benefit to employees of a growing company. It is important to keep in mind that while there is potential for great reward, this type of compensation model is not without its risks. Stock purchased through employee stock option programs are as exposed to market risk as any other investment. It is a good idea to not put all your eggs in one basket and have a well-diversified investment strategy outside of your employer.