6 top pros and cons of stock options

Giving staff stock options and, if offered them, choosing whether to accept them, may not be as straightforward as they at first seem. So, here’s some thoughts on when to grab stock options, what to avoid and how to benefit:

Pros

1. It’s free money – of a sort

If you’re offered stock options, take a hard look. Some have real potential to generate long-term riches, though you often have to wait several years before a stock option ‘vests’.

That’s the waiting time before a stock is sold or transferred to you. Some plans are far riskier than others - as we’ll see.

2. Don’t sniff at tax sweeteners

Not all have tax benefits, but some do. The Inland Revenue has a number of tax-efficient approved plans you may be eligible for: SIP, SAYE, CSOP and EMI.

• The first two schemes, SIP (Share Incentive Plan) and SAYE (Save As You Earn), tend to be used by larger organisations and contain income tax and national insurance tax breaks
• CSOP (Company Share Option Plan) and EMI (Enterprise Management Incentive) are more discretionary. They’re still treated considerably more positively by HMRC than non-approved share option schemes
• CSOP allows up to £30,000 per employee; the EMI scheme extends to £250,000 of market value. Be aware there are tight strings attached. For example, employees must work for the company 75% of their working time

3. Risk free – up to a point

Some schemes, such as SAYE, allow you to buy into your employer’s shares at discount. If the share price rises, great. And if the share price falls you still get your money back.

The only disadvantage is if the company’s share price fails to rise at all. Your money could be working rather harder elsewhere.

4. Great for cash flow

Very important for a small company, especially if you’re the boss. “If you can’t afford to give pay rises to staff,” says Charles Cotton, performance and reward adviser at the Chartered Institute of Personnel and Development (CIPD), “they [stock options] are a good idea, though you will need to spend time on education, communicating their benefits to staff.”

Stock options can be a substitute for a pay rise

5. They incentivise (you hope)

From boardroom right down to the lower corporate rungs, stock options are often designed as an extra carrot plus stick. If staff are incentivised, goes the theory, the more productive they’ll be.

(This, note, isn’t always true: recent research suggests that, like a failing diet, a performance change may only be temporary.)

6. Zero charges

Stock options generally don’t come with charges attached. While a few quid in fees doesn’t add up to much initially, monthly fees from conventional stock market savings vehicles sap the energy of savings long term, draining performance potential.

Stock options tend not to come with such tiresome, wealth-draining charges.

Cons

1. Major small print/footnote warning

There’s a raft of checks to make before committing. “Is the company listed or unlisted,” says Ruth Bender, professor of corporate financial strategy at Cranfield School of Management.

“If it’s unlisted then there’s no share price, as such. How will the stock option price be set? Ask questions.”

• If the company’s unlisted and the shares vest, when can you sell?
• Who exactly will determine the price - and how will it be calculated?
• If it all looks too good to be true it probably is

2. Share price risk

In good times, a soaring share price is a boost for staff. Good times generally don’t last forever. “From the employer’s perspective, if the share price falls then it can seriously damage staff morale,” warns the CIPD’s Charles Cotton. For example:

• In October 2016 the value of Twitter shares crashed 27%
• Potential buyers – thought to include Disney and Apple – lost interest in the stock. While not great news for Twitter, it was a sizeable ‘paper’ setback for some staff
• A tumbling share price can trigger staff attrition rates. Sinking shares are not good news for other investors tied into the company, piling on volatility. (Some schemes, as already indicated, do offer safeguards though.)

3. Watch your timing

It may be a three-year wait before reaping the benefit of a stock option. “If you leave before, say, three years are up, do you fit into the ‘good’ leaver,” Ruth Bender warns, “or ‘bad’ leaver category?

In other words, you might leave because of ill health, or you’re fired.” Or you might just want a change of professional scene. Some tight career planning may be needed so you don’t forfeit your rights.

4. Beware of tax risk

Careful tax planning may be needed, ensuring you’re in the lowest possible tax bracket when it’s time to sell. Bear in mind that some stock option plans may have a ‘use-it-or-lose-it’ clause also.

5. Too many eggs in a basket

Sensible diversification, please. If you pile savings into a work stock options scheme you’re making an impressive statement about the long-term wits of your colleagues and boss. It may be undeserved. Avoid sticking too much of your savings in one pot.

6. A last word of caution

Long-term stock options are a debt or mortgage on the future performance of a business. If there’s a takeover or merger, the value of the future stock option debt may shrink the share price. Treat long-term share price projections with extreme caution.