What are employee stock options?

Employee stock options (ESOs) are a form of compensation in which an employer grants an employee the right to buy a specific number of shares of the company’s stock. ESOs are typically offered to reward performance and longevity, attract qualified candidates, or encourage employees to feel a sense of ownership in the company.

The options agreement will typically specify the date and price (called the exercise price or strike price) at which employees can exercise their option. Options agreements may also contain a vesting schedule and are usually non-transferrable.

What are the benefits of exercising employee stock options?

The strike price for shares purchased through ESOs is often the market price of the stock at the time the option is extended to the employee. Sometimes, the strike price reflects a discount off the market price. Assuming that the market price rises between the time that the options are offered and the time that employees can exercise their options, ESOs can be a profitable investment.

What are the types of stock options and how can they impact taxes?

Stock options generally fall into two main categories: incentive stock options (ISOs) and non-qualified stock options (NQSOs or NSOs). ISOs are usually taxed at the capital gains rate but often require the employee to hold the stock for a specified period of time after purchase. NSOs are taxed at the higher ordinary income rate, but employees can sell the stock at any time after purchase, avoiding the risk of holding the stock.

Exercising stock options can have other tax ramifications. Your Allen & Company Financial Advisor can work in partnership with your accountant or other tax expert to help you understand these issues before you exercise your options and guide you through the process.

When and how should investors exercise stock options?

Most stock options agreements specify an expiration date. Once the expiration date passes, the employee can no longer exercise their options.

There are a variety of ways in which you can raise the funds required to exercise your options, from trading other shares of stock and liquidating other assets to debt financing. Your Allen & Company Financial Advisor can assist you with determining what the right time is to exercise your options and the best choice to fund your investment.