Done with appraisals and awarded with stock options instead of a big raise? Here’s what it means for you.

Many employers, especially in the technology sector, have joined the trend of offering stock options to attract and retain talent. If you don’t know what that means, you’re at the right place. Here’s all you need to know about employee stock options:

Employee stock options are generally a part of the employment agreement you sign with your company or equity compensation for good performance. By signing this agreement, you agree to purchase a particular number of shares at a specific price, which is at a discount. The stocks you buy will be at a price lower than the market rate at the time. What’s the benefit, you ask?

Well, you have the freedom to then sell these shares at a time when the value is higher. This happens when the company does better. So, it’s a win-win for both employer and employee.

Now that we know what employee stock option is let’s find out the difference between restricted stock and stock options. In simple terms, a stock option is an umbrella term for all kinds of stock options where the stockholder has the right to buy or sell their shares. Restricted stock units are a type of employee stock option with some restrictions in place.

Restricted stock units vs stock options

Stock options and restricted stock units are both used as a compensation measure to attract high-performing employees and retain them. The significant difference between restricted stock and stock options is that with restricted stock units (RSU), you do not immediately own the shares that you purchased.

Here’s an example that will help you understand. Ankita was recently hired by a company that offered 2,000 shares as stock options for three years. Her sister, Shreya, on the other hand, landed a job that provides 2,000 shares as RSUs for five years, with a vesting schedule of 400 shares every year.

So, Ankita has purchased the 2,000 shares of the company she has joined. In the next three years, Ankita has the liberty to sell these shares partially or altogether to get a profit.

Shreya, on the other hand, will not be able to do so immediately and have to wait till she has complete control over the shares. This is called vesting. So, after completing one year at her company, Shreya can have control of 400 shares. Over the five years, she will be able to gain control over her shares in parts. However, for tax purposes, all of Shreya’s 2,000 shares will be treated as additional income every year, which is taxable.

Another difference between restricted stock and stock options is that while stock option holders have all the rights that shareholders have, those holding RSUs have restricted rights. This includes the right to vote in the annual meeting. Dividends paid to stock option holders are the same as any ordinary shareholder. That’s not the case with RSU holders.

Usually, if an employee sticks around with the company even after the stock options period has expired, companies offer refreshers to retain talent. So, if your RSU period is coming to an end, you can request your employer for a refresher.

Conclusion

Stock options are an attractive alternative to salary compensation. If used wisely, these options can significantly improve the net worth of the employee.

While you have the freedom to choose what to do with your shares in the company, we recommend you analyse all your options to get the most profit. One of the ways to do so, if you are holding RSUs, is to sell them immediately when they vest and invest the profits in investment tools that give you tax benefits.