Incentive Stock Options: What it means for employees?
Every company has its own compensation strategy for its employees. These strategies are rolled out with the intent of appreciating and attracting deserving candidates who can play key roles in accelerating the company’s growth in the market. One such strategy is to offer employees stock options to make them feel a sense of ownership with the company. Incentive Stock Options are widely embraced by employers as a part of employee benefits. This article throws light on what ISO means to the employees and the factors to consider when accepting an ISO from the company.
What are Incentive Stock Options?
Certain companies provide their employees the right to purchase company shares at a modified rate in their favor. This compensatory benefit is called Incentive Stock Options. Most companies offer these options to the management-level staff or the employees they consider an asset to the organization. This way, they can both incentivize the staff and also retain them, which in turn adds value to the company. As the company shares increase in value over a period that an employee is associated with, he can enjoy the rewards his stock options offer.
How does an ISO work?
The stock options are offered to the employees at a specific date called the ‘grant date’ with a discounted rate known as the ‘strike price’. If there is a vesting period — a waiting period after which they can exercise their right over the stocks, the employees should hold on until then. The vesting period can be either a standard 3-year cliff or graded where the employees experience a progressive rate of exercise right every year. After serving the vesting time, the staff can utilize the stock at a strike price and estimate the bargain element (the profit rate). Examining the market conditions, they can either choose to buy or sell the options and make revenue.
For example, your company offers you 100 shares at a set price of $6 each and the market price might go up to $30 in a few years. In that case, you can still purchase more shares at the same $6 discounted rate.
How to exercise the ISO?
The ISOs usually have an expiry time frame of 10 years. If you are an employee with an ISO reward, you should exercise your stocks within this time frame. Similarly, if you quit working for the company, you should use the stocks within 3 months to avoid unfavorable taxation. There are options like ‘same-day sale’ where you can sell a part of your allotted shares to compensate for the cover cost, or ‘sell-to-cover’ which is also a similar option, or even ‘stock swap’ if you want to buy more shares using the company shares without paying for any. Not all companies offer cashless exercise options to their employees. It is better to have a clear idea of how the stocks work before considering the exercise options.
Recently in October 2022, the Winshear Gold Corp of Peru allocated 2,000,000 Incentive Stock Options to their employees, including the officers and directors. They were offered at $0.10 per share with a quarterly vesting time frame.
How is an ISO beneficial to the employee?
The most important of all the benefits that ISO offers to employees are listed here.
Tax benefits
The tax benefits involved in ISOs are the best reasons to proceed with them. There are no income taxes levied on ISO-related revenue in most cases. However, You can expect capital gains tax once you start generating income from your stock options exercise. Unlike other non-qualified stock options offered by employers, the ISOs do not impose both income tax and capital gains tax on your profits. Also, it is recommended to verify if there is any need to pay an alternative minimum tax (AMT) if you hold on for a year or two before exercising your options.
No expenses on exercising stock options
It is not necessary to involve cash in whatever you do with your employee stocks. If you feel the company share values will see a rise in the next few years, you can opt for ‘share withholding’ to gain profits. Similarly, the stock swap method allows you to purchase more shares using the ones your company offered you.
For example, if your company has offered you 100 shares for a strike price of $10 each as your ISO. If you find shares being traded at $20 each, you can buy more shares using a portion of the available shares. Let’s say you are swapping 50 shares, you can purchase 100 new shares by swapping the 50 ($20× 50= $100).
Liberty to exercise options
Though there are vesting schedules, you can choose when and how you want to exercise your power over the shares. If you sense a potential value rise for your shares in the market, you can hold your stocks as long as you want. Or if you believe the current value is sure to generate profit you can sell them. Remember, the company regulations regarding vesting and retirement should be followed to enjoy the benefits.
Participation in the company’s growth
The sense of ownership that an ISO offers at no financial risk is the key motivating factor from an employee’s perspective. Since it is a reward there are no hidden costs. When your company grows in value, the stock prices increase. When you own some of these stocks, you feel more involved in the company development and work harder for the same. This is a two-way benefit for both the employees and employers as the ultimate objective is business progress.
Summing up
Equity compensations need proper planning and knowledge about market trends and company values. It is recommended to have a financial consultant to guide you through the process of understanding stocks and exercising them. Eqvista has a team of expert consultants who can ease your journey with timely clarifications and suggestions. If you have queries on options for exercising methods or looking to set up an ISO plan for your employees, contact us right away!
