As you grow in your career, you’ll find an increasing number of opportunities that contain Employee Stock Options (ESO) as part of your compensation package. The question is, are these stock options worth it?
What is an ESO?
An employee stock option is a financial instrument that specifies certain terms as to when you can buy a company’s shares. Most commonly these ESOs will be offered with a set price, and a vesting period.
While the price is self-explanatory, the vesting period bears careful consideration.
A vesting period is a predetermined amount of time that must pass before you can execute, or buy, the shares in the option. These can be slowly released over time (33% per year for 3 years), or your options could vest all at once (100% after 3 years).
Public Vs. Private Stock Options
A share is simply an ownership stake in the company. That means both public and privately traded companies can offer stock options, but there are considerable differences that you need to understand.
As a public company is traded on a financial market, those shares are easily bought and sold. This makes it easy to liquidate your position, or unlock the cash that was held behind those shares.
Private companies aren’t quite so straightforward.
For a private company, where there isn’t an open market for those shares, getting rid of them can be considerably more challenging. To sell, you would need to wait for a liquidating event. This could be in the form of a merger, acquisition, or an IPO, or far more infrequently, if the company allows you to sell to a private offer. The key point here is that your money, tied up in shares of a private corporation, could be very hard if not impossible to recover.
Risk Vs. Reward
Ultimately whether you should look for ESO or salary in your compensation agreement depends on your risk tolerance. Investing in a single company is risky. Stock Options are therefore a riskier option to taking your compensation through salary.
While we would all like to think our efforts at work will make the company successful, companies rarely hinge on the efforts of just one person. There are a variety of factors at play, which could impact the future share price. While you could see some incredible returns, those same stock options, assuming you can even sell them, might produce a 0% or even negative returns in these ever-changing market conditions.
Another element of risk is introduced by the vesting period, as a lot can happen in that time. Maybe you realize your job, or the company, isn’t for you. Or the company decides that you aren’t the right fit, or to move in another direction. Anything unvested at that point in time would be lost to you.
Finally, any compensation tied up in Stock Options isn’t available to you as cash to spend. While the returns on ESOs can be remarkable, they only benefit you if you don’t need the cash now, and can afford to wait for the vesting period and/or liquidating event.
Are ESOs Right For You?
Ultimately, only you can answer that question depending on your own financial position, and financial goals.
When I was offered an ESO a couple years ago, I turned down the opportunity in favor of cash in hand. My financial plan had our first home purchase planned, and the cash was more valuable to me than potential returns at an unknown time in the future. Living happily in that first home now, I can say the decision was the right one.
But, times today are different for me. If the same opportunity was presented today, I would gladly take on the risk, with the right company.
So you see, there is no right or wrong answer. How you decide if an ESO is right for you will depend entirely on your situation, and that answer can change as you continue to grow through life. What is important is that you understand your financial plan, where you are, and where you’re going. As long as you’re comfortable with the risk, an ESO might help speed you along your journey.