When making job offers to new hires, some companies propose a lower salary in exchange for employee stock options. “It’s very common in Silicon Valley with small, early-stage, private startups. You also see it with very large, public companies like Walmart, Whole Foods, and Netflix,” says Alison Norris, a Certified Financial Planner™ professional at SoFi.
Here, we’ll walk through how stock options work, the pros and cons of purchasing them, and whether or not this form of compensation is right for you. Consider the following when faced with this type of offer.
Salary vs. Stock Options
Here’s the #1 thing to keep in mind. “Your base salary—without any equity—should cover all of your living expenses,” says Norris. Any form of equity compensation is essentially a gamble, so you want to make sure that you can survive on your paycheck.
“Stock options can lead to a big payout, but purchased shares can also lose value. And for many who choose not to exercise, stock options may have no impact on wealth and simply expire worthless. So think of equity as icing on the cake: delicious, but not sustenance,” Norris adds.
Not sure what number to ask for? Do some research so you have a ballpark idea of what to expect. Analyze what the average salaries are for the position that you’re seeking by visiting a site like Payscale.com. “It won’t be perfect, but it can give you some data points and a good range,” says Jennifer Zamora, a career coach at SoFi and Korn Ferry. And if you know people who already work within that industry, buy them coffee or lunch to pick their brains.
If the initial salary offer is lower than you were hoping for, try negotiating. “It never hurts to ask for a better offer,” says Zamora. “Just be thoughtful about your tone and your language. Show confidence and sincerity in the ask, and be prepared that the company may not be able to increase the number.”
How do Stock Options Work?
First, a quick stock options definition: When you receive an offer that includes options, it really means the ability to buy shares of a company and become a part owner. It’s a form of equity compensation.
Usually, you don’t get to purchase stock options right away—the timeline is based on your “vesting schedule”. “It’s common to have a four-year vesting period with a one-year cliff—it’s a retention strategy,” says Norris.
In other words, the ability to purchase stock won’t be available to you at all if you plan on leaving the company within one year, and fewer options will be available to you if you plan on leaving the company within four years. So keep that timetable in mind when you’re weighing a job offer.
If you ultimately “exercise” your options, you then pay money to own company stock. But what happens next —and whether you eventually make money on that stock—depends on all kinds of factors.
Questions to Ask About Your Options
Norris recommends asking detailed questions of your prospective employer so you fully understand what your offer of stock options means. And remember, contractual language can be vague, so make sure you ask the company’s founders or HR these key questions if certain details aren’t already spelled out for you.
1. Are These Incentive Stock Options or Non-Qualified Stock Options?
“It’s often better to receive incentive stock options because, in most cases, you don’t pay any taxes when you purchase the shares. You pay taxes only when you sell, so you’re delaying costs,” says Norris. ”
Also, you may be able to pay fewer taxes by qualifying for a lower tax rate on any gains that you have. The caveat there is: You do pay taxes if you’re subject to an alternative minimum tax (AMT), but AMT is projected to apply fewer people under new tax law.” If you have questions about how this might affect you, talk to a tax or legal professional.
If you’re being offered non-qualified stock options, an employer probably won’t be able to change the option, but you may be able to use that as a negotiating tool. Use this tip from Norris: “You might say to them, ‘I’m looking forward to becoming a partial owner and having equity, however, I recognize that I’ll have to pay taxes on the gains and pay out of my pocket.
For that reason, can you either increase the number of options or cover the tax expense on my behalf?'” Review your options in conjunction with your tax advisor to determine if you are permitted to recognize income on the shares before they vest, potentially reducing the adverse tax consequences of the future exercise.
2. What is the “Exercise” (or “Strike”) Price?
The “exercise” or “strike” price is the amount of money you’ll pay for the stock at a later date if you choose to buy it. It’s a fixed price, meaning it won’t change over time. However, the “market” price—or what the stock is currently worth in the eyes of investors—will. “Stock options have value to you when the exercise price is lower than the market price,” says Norris.
And you can’t wait forever for the market price to increase. The employer should tell you when the stock options expire. Often, if you choose to buy them, you have to do so within 10 years or within 90 days of when you leave the company, says Norris. Find out what the exact terms are.
3. What is my Percentage Ownership?
Remember: It’s not the number of shares that matters—it’s the percentage ownership that you’ll have in the company. If the stock options aren’t framed in terms of a percentage in your offer, ask how many shares are outstanding and do some quick back of the napkin math.
Then, if it’s a private company, ask what the valuation of the company was during its last round of funding. If it’s a public company, Google the “market cap” for that company. This information will help you figure out what your percentage is currently worth.
But be wary of something called “dilution.” Let’s say you’re offered 1% ownership of the company. But then the following year, the company offers shares to dozens of other investors. Unless you see a specific “anti-dilution” provision in your contract, your percentage of ownership may go down over time.
So you could ask the employer questions like, “Are you planning another funding round?” If the answer is “yes,” then you’re likely to face some dilution.
4. How do I Sell my Shares?
Ultimately, you’ll want to know how you’ll have the potential to make money on your stock. If the company is already public, “you can likely sell your shares earlier in the open market, even if you stay employed with the same company (though employees sometimes have blackout periods and sell restrictions),” Norris notes. Be sure you’re clear on the guidelines and requirements.
But if you own equity in a private company, you can’t just sell those shares any time, so you’ll want to know what the probable exit will be for the company down the line. For instance, does the company plan to be acquired, or is it hoping to IPO?
Either way, remember that so much of your financial upside depends on whether the valuation of the company goes up or down over time. Like investing in anything, buying your company stock is taking a risk.
If the company does go up in value, that’s obviously good for your wallet. If the company goes down in value, you’re basically out of luck. “The moral of the story is to not put all of your eggs in one basket,” says Norris “Especially when you consider that your human capital, your paycheck, is already tied to the financial success of your employer.”
Looking at the Big Picture
Lastly, ask yourself some deep questions. How do you feel about the company’s future? What’s your tolerance for risk? Are you personally motivated by potentially owning a portion of the company? Is this the sort of compensation that is appealing to you? If your options end up not being worth much, how will you feel about your salary and your experience with the company?
Once you start thinking about the answers, you’ll have better sense of how enticing (or not) stock options for this particular company actually are.
Still not sure which way to go? Don’t sweat it. If you’re a SoFi member, sign up for a complimentary one on one coaching session. We’ve partnered with Korn Ferry Advance to give you access to professional career coaches, who can help you plot your path forward. Not a SoFi member yet? Head to SoFi.com to learn more.
SoFi can’t guarantee future financial performance.
This information isn’t financial advice. Investment decisions should be based on specific financial needs, goals and risk appetite.
SoFi does not render tax or legal advice. Individual circumstances are unique and we recommend that you consult with a qualified tax advisor for your specific needs.
Certified Financial Planner Board of Standards Inc. (CFP Board) owns the certification marks CFP®, CERTIFIED FINANCIAL PLANNER™, CFP® (with plaque design), and CFP® (with flame design) in the U.S., which it awards to individuals who successfully complete CFP Board’s initial and ongoing certification requirements.
Advisory services offered through SoFi Wealth, LLC, a registered investment advisor.
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