Help me understand this employee stock option plan

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cflannagan
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Help me understand this employee stock option plan

Post by cflannagan » Fri Oct 04, 2013 8:48 am

This is the more recent plan presented to me (at beginning of January 1 2013). I was also presented another plan back in 2009 when I was hired (which I don't have with me right now, it's in files at home). I'll quote the relevant parts:
Type of option: Nonstatutory Option
This option may be exercised with respect to the first 25% of the Shares subject to this option when the Optionee completes 12 months of continuous Service after the Vesting Commencement Date set forth below. This option may be exercised with respect to an additional 1/48th of the Shares subject to this option when the Optionee completes each month of continuous Service thereafter.
Vesting Commencement Date: January 1, 2013
This option expires earlier if the Optionee's Service terminates earlier, as provided in Section 6 of the Option Agreement.
So far, what I understand is that I will have immediate access to 25% of shares shown below on January 1, 2014 (a year later after vesting commencement date):
2,800 Series B Common Shares
600 Tier 1 Incentive Shares
600 Tier 2 Incentive Shares
And then additional 1/48 of those shares for every month thereafter as long as I am employed.

Questions:

1) Does this mean I will continue to get 1/48 of those shares for every months thereafter, even after year 5 after the vesting commencement date, or does it stop once 100% of those shares shown above is reached?

2) Unless I am mistaken, I think most does not exercise anything until certain events occur (like going public) and they then sell shares right away. Why not just exercise it on January 1, 2014 and own shares (without selling), and continue to accumulate 1/48 for each month thereafter (exercising every month, without selling shares)? I know it probably doesn't work that way, that's why I'm asking for Boglehead-type help.

By the way, assumption is that right now the shares aren't really worth anything right now anyway if I wanted to exercise the option.

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mhc
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Re: Help me understand this employee stock option plan

Post by mhc » Fri Oct 04, 2013 10:04 am

You will stop getting shares once 100% vests. The 1/48th does not go on indefinitely.

Do not exercise shares until you are ready to sell them. There is no reason to buy and hold in the boglehead philosophy. You should not buy the 25% as soon as they vest and hold. What happens if the share price drops below your purchase price? You lose money. If you keep them as options and the price drops, you do not lose money.

I usually hold my options until they are close to expiring unless they are up dramatically from the option price. There have been some posts about using the Black Scholes pricing model (google it) to determine when to sell.

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cflannagan
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Re: Help me understand this employee stock option plan

Post by cflannagan » Fri Oct 04, 2013 10:31 am

mhc wrote:You should not buy the 25% as soon as they vest and hold. What happens if the share price drops below your purchase price? You lose money.
At what price would I be "buying" those shares at when I exercise the option? The vested shares don't come to me free when I exercise?

I'm trying to understand what the difference is between just going ahead and owning the vested shares now and then selling later vs exercising and then immediately selling, when both of those events require me to pick an arbitrary day to sell the shares and hope it's a "good day" to sell.

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FNK
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Re: Help me understand this employee stock option plan

Post by FNK » Fri Oct 04, 2013 10:38 am

Your exercise price is supposed to be in your actual grant document.

Incentive options have the great feature that if you exercise one year after vesting and sell after another year, you get to book everything as long term capital gains. May be worth it to hold for a year.

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mhc
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Re: Help me understand this employee stock option plan

Post by mhc » Fri Oct 04, 2013 11:50 am

cflannagan wrote:
mhc wrote:You should not buy the 25% as soon as they vest and hold. What happens if the share price drops below your purchase price? You lose money.
At what price would I be "buying" those shares at when I exercise the option? The vested shares don't come to me free when I exercise?

I'm trying to understand what the difference is between just going ahead and owning the vested shares now and then selling later vs exercising and then immediately selling, when both of those events require me to pick an arbitrary day to sell the shares and hope it's a "good day" to sell.
You minimize your risk by not exercising the options until you are ready to sell. If you exercise and hold the shares, the share price may drop and you would lose money. If instead you kept the options, you would not lose money.

I think there are 4 basic scenario's.
OP=option price
FMV0=fair market value when exercising options
FMV1=fair market value when selling shares

scenario 1: (underwater)
FMV<OP then don't exercise

scenario 2: (buy and hold)
FMV0>OP and FMV0<FMV1, you win

scenario 3: (buy and hold)
FMV0>OP and FMV0>FMV1, you lose

scenario 4: (buy and sell immediately)
FMV0>OP and FMV0=FMV1, you win

scenario 2 is the best (assuming LTCG less than marginal tax rate, otherwise about the same as #4), but you cannot guarantee that will happen. Scenario 4 is second best, and you can take that option whenever it presents itself.

jcw
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Re: Help me understand this employee stock option plan

Post by jcw » Fri Oct 04, 2013 12:06 pm

You should also think about the forward exercise if the strike price and fair market value are very low. Forward exercise allows you to turn the option into a restricted stock unit and you pay taxes on it immediately. This makes sense in very early stage ventures. So if the strike price is $0.01 and market value is 0.05, you would have to pay taxes on $0.04 per share, which is basically nothing. This article describes it better:

http://gigaom.com/2011/06/05/5-mistakes ... k-options/

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