Whether you work at a publicly owned company that trades on the stock market, or a privately owned company that has its own common shares, employee stock options and shares are a way to incentivize employees to remain at the company. Most average Canadians don’t understand the stock market nor do they have motivation to learn about it. When the words options and shares are bandied around at the office it probably sounds intimidating or downright confusing.
The real question everyone wants to know about options and shares is “How does this benefit me?” Your finances are extremely important to you, and no doubt you want to make the best decision for yourself. No matter what the employer says, you want to make an informed decision that you can be comfortable with. When you don’t feel comfortable with something, it’s in our human nature to avoid it.
So why should you consider stock options and shares from the company you work with? What benefits do you get? How risky is this kind of investment? What factors should go into this decision? All the answers to the above questions depends on your own personal opinion; however, read on to find out what things you should consider.
Stock Options vs Shares
The company you work with will either offer you stock options or shares. When a company gives you shares they are generally called restricted stock units (RSUs). The difference between options and shares is that with options, you are given a contract for the right to purchase shares at a specific price at a specific date. If you are given shares, usually they are given to you as a bonus, which means that you don’t have to pay anything. With either method, companies will usually vest your options or shares meaning they will be given to you over a period of time. The longer you stay with the company the more you get.
In Canada, receiving shares is like getting a money bonus. You will get taxed on the value of the shares at your marginal income tax rate. The great thing about shares is that it’s like getting money handed to you, but the taxation of shares makes it very unfavourable for you. With options, you are given a contract to purchase shares in the future. You don’t ever have to buy these shares if you don’t want to. The decision to actually buy shares can come at a later time when you can judge how well the company has performed. If the prices of the shares have gone up, it becomes a no brainer to buy your shares at the lower contract price. Only capital gains will be taxed when you exercise your option to buy. This is more favourable because capital gains are taxed at 50% of the gain at your marginal rate. In most cases, options are more flexible and preferred if you want to get shares in the company you work for.
Share Matching Plan
Some companies will match your contribution of stock purchases by giving you additional shares. If you company offers this type of compensation, then by all means go for it. Who doesn’t like getting free money? The extra shares you gain from the company can be considered an additional bonus. Even if you don’t want the shares buying and receiving more and then selling everything will still net you a gain.
You Know The Company Well
Unlike buying stocks of random companies, you of all people should know how well the company is doing. Do you fear for your job loss? Is there growth in the company? Is the revenue growing? Is the company profitable? If you work at a large blue chip company (utilities, banks, big tech, etc..), you are really looking to see if the company continues to grow its profit and dividend. If they are, then it makes perfect sense to take part in being an owner of your company. Why wouldn’t you want a share of the profits and payouts?
For smaller companies that are rapidly growing, the key aspect to focus on is whether the revenue of the company is continuing to grow and whether margins for the business are improving. Sometimes too much emphasis is put on cash flow because every CEO wants to proclaim that “I just scored a $50M investment for the company!”. It sounds awesome when you get a lot of funding because it validates the existence of your company, but ultimately you want to see if the company will survive. A company that is starting out and growing needs to show that it can achieve profitability. I use the analogy of a sports athlete who makes millions of dollars a year, but eventually goes bankrupt? Those that can continue to thrive survive, those that don’t just have a good ride.
What’s In It For You?
We talk about greedy corporations and businesses, but you’re really being a hater because you’re not part of it. That’s why you own the shares to become an owner. For large companies you want to share in the profit of the company. Banks make billions, so why not take a piece of the pie? For smaller companies you want to catch the train when the value is low and ride it up as the company prospers. Capital appreciation is more important for smaller companies than profit sharing, but once the company grows and starts making a large profit, then the latter point becomes more important.
If you work at a private company the ability to sell your shares could be quite limited. This means that it isn’t easy to convert your shares to real dollars in case you need the money. Before taking the dive and buying a large allotment of shares, consider what your own personal financial situation is like and what it would mean to have your money tied up. Do you need the money in the short term, or can you put it away and not have to think about it?
Some companies might have a secondary market where owners within the company can trade with each other. This provides a means for you to sell your shares in the case that money is needed immediately. The added flexibility might allow you to purchase the shares even if you have a short term goal.
If the shares of the company that you work at are publicly traded on the stock market, then the shares will be extremely liquid. This is the beauty of investing in the stock market because you can sell your shares and it can be converted into cash with the click of a button.
For smaller companies that might be offering shares as a substitute for compensation, you will have to weigh the value of the money right now versus what the value of the shares may become. Money now is almost always better than money in the future because of inflation. This doesn’t mean that taking shares and options is a bad idea because the value of a company could grow faster than what you could do with your money. This is only something that you can judge personally because it really comes down to your own personal finances. You will have to weigh whether a higher salary is better now or the prospects of the company in the future will put you in a better financial position.
When in doubt, negotiate with your company to balance shares and options versus your own salary. Perhaps there is a happy medium where you can settle for less shares but take a greater increase in your regular pay. Realize that as a valued employee, you have leverage as well.
The one trap you don’t want to fall into with company shares is investing too much of your money with one company. Remember that the key to having a successful investment portfolio is to diversify into many assets. Since shares and options require your own after tax dollars to purchase, you want to ensure that you have additional funds left over after making share purchases to buy other investment assets.
Make the shares of your company part of your entire investment portfolio. Shares in your own company should be considered to be stocks. Do you have enough fixed income assets to balance it out? Remember that if the company you work at falls into bad times, you don’t want to worry about your job and all of your savings. This is the one big downside of putting all your eggs in one basket. Think BlackBerry.
Whether or not you buy shares at the company you work at is a personal decision. The fact that you are an employee at the company gives you a good insider look at how well the company is doing and whether you want to be a part of the success at the company. Don’t be afraid to ask questions and clarify any misconceptions you might have with your employer. Ultimately you want to mitigate risk and feel comfortable investing in the company.