In September 2021, the Wall Street Journal published an article describing how women's lack of understanding of equity compensation could be contributing to the gender pay gap. It tells the story of a woman who negotiated for more stock options when she was joining a new employer, and in doing so, made $1.5M from them in five years. She knew to negotiate given she had spent her career as a corporate attorney working on stock option plans. Unfortunately, most women do not have this kind of experience and therefore may not feel comfortable negotiating their equity. This could be a factor behind the gender gap seen in equity compensation – a study from the Rutgers Institute found that male employees held an average of $104,902 in company shares, whereas women only held an average of $26,361.
I do believe equity compensation is a contributor to the gender pay gap, and in turn the gender wealth gap which sees women having 32 cents for every dollar men have. While equity compensation is less understood than other elements of compensation, I have found it is more often negotiated and less standardized within companies (meaning there is more room for negotiation). One of my goals is to demystify the understanding of equity compensation to create a more level playing field in negotiations.
Employee Stock Options 101
I am starting off with a relatively common type of equity compensation: stock options. It is important to note I’m describing stock options as used for employee compensation, not stock options as traded in the broader capital markets. I also am describing employee stock options generally; there can be nuances and complexities within different companies and structures.
Overall, a stock option gives you the ability to purchase shares of your employer at a certain share price at a future date. At first glance, this doesn’t seem like compensation. If your company is public, you can buy shares yourself. How is this beneficial to you? It is beneficial because the price that you can purchase the shares at is the share price on the day the stock options were granted to you (i.e., the date you were awarded them). Hopefully the price the stock options were granted at is lower than the price on the day that they become yours to action (called the "vest" date).
Example: 5,000 stock options were granted to you on November 1, 2021 when the company share price is $10. The options vest (become yours to action) one year after grant. On November 1, 2022, the company share price is $25. At this time, you are able to purchase the shares at $10 (the grant date share price), when their value is really now $25. This means you are getting a $15 discount off each share ($25 - $10 = $15).
- A $15 discount off each share x 5,000 options = $75,000 value. If your employer is a public company with no trading restrictions, you can sell the shares on the market, and that $75,000 gain is yours (excluding tax considerations).
- If your employer is not a public company, you may not have the ability to get cash in hand immediately, but it does give you the ability to own shares at a lower buy-in.
Some Notes & Tips:
These notes and tips explain at a high level some of the technical aspects and considerations of stock options, to help familiarize you with key terms and concepts.
- Risk profile: Stock options only have value if the share price increases from the grant date. In the example above, if the share price is $5 at the vest date, your stock options are worth nothing at that time (because they were granted at $10). In this way, they are riskier than some other forms of equity compensation because their value is fully dependent on how the share price performs.
- Understand this risk profile when negotiating, and reference historical share prices if needed. If you believe in the company and its share price potential, stock options are great as you can see material gain from share price increases. If you are less certain on the company’s performance, I would consider restricted share units or other forms of more stable compensation.
- Vesting period: Most stock options do not actually become yours for multiple years. So while you are granted (for example) 5,000 options now, they may vest (for example), 1,250 in one year, 1,250 in two years, 1,250 in three years, 1,250 in four years. This is used as a retention tool to keep you at a company over the long term, because you can see the value of your stock options, but you cannot access them yet.
- Expiration: Stock options expire after a certain period of time. For example, you are granted 5,000 options now that expire in five years. This means after the five years, if you have not actioned the stock options, they are void. Stock options with longer expiration periods are typically better, because it provides more opportunities for the share price to increase.
- Valuation: Stock options are valued in a more complex way than most other forms of equity. If a company offers you 5,000 stock options, this does not mean their value is 5,000 multiplied by the share price. A Black-Scholes or binomial valuation method is typically used which takes into account factors such as share price volatility and expiration dates.
- If you are being granted a number of units, I would encourage you to ask how they are valued and what their grant date value is so you can understand exactly what you are receiving. Stock options are not valued as the equivalent to a share as they are riskier (a restricted share unit will have value even if the share price goes down, whereas an option will not).
- Actioning: Just because an option has vested, does not mean you have to action it. If you think the share price will continue increasing and you will get more value, you can hold it until the expiry date of the options. There are also other ways to action stock options beyond just selling them for cash; for example you can choose to purchase the shares at the grant price, and hold them.
- Plan Text and Agreements: When negotiating equity, I suggest looking up the equity plan text (if the company is public) or requesting the stock option agreement. This can help you understand the program nuances like termination clauses (what happens to your equity if you leave the company, if you are terminated, if there is a change in control, etc.), valuation, how often equity is granted, vesting schedules, potential for program changes, and so on.
- Tax: equity tax is complex and can change based on location and program structure. In North America, stock options are generally not taxed when they vest (whereas full share units generally are). However, options are typically taxed once you action them, and if you hold the underlying shares and sell them later, they are then again taxed at sale (capital gains).
- In this way, options are beneficial as you can time the taxable event; however, depending on how your company structures the plan, you may need to set aside money to cover the costs at the end of the year. Things like company travel and changing tax laws can have significant impact on your taxes. If the value of your stock options are material, I recommend getting a tax advisor to ensure you are covering your bases.
Again, the above describes employee stock options generally; there can be many different structures and nuances. If stock options are something you receive now or have the potential to receive in the future, take the time to understand the program. It also is important to understand how stock options compare to restricted share units, performance share units, deferred share units, and share appreciation rights – I will save those for another article. And when in doubt, ask an expert. Earning potential (and closing the gender pay gap) can be impacted by informed equity management. If you have any questions, please do not hesitate to reach out at [email protected].