Stock Options For Dummies

Introduction 1 Why I Wrote This Book: The Lessons of 1999 and 2000 1 Who Needs to Read This Book? 3 How to Use This Book 3 How This Book Is Organized 4 Part I: The Fundamentals of Stock Options 4 Part II: Details, Details: What You Must Know About Your Stock Options 5 Part III: Money! 5 Part IV: Pay Up! Taxes and Stock Options 6 Part V: Changes and Special Circumstances 6 Part VI: The Part of Tens 6 Icons Used in This Book 7 Part I: The Fundmentals of Stock Options 9 Chapter 1: Stock Options: What You Need to Know Right Off the Bat 11 Understanding Stock Option Basics 11 Knowing what stock options are 12 Knowing how stock options work 13 Exercising Your Stock Option(s) 15 Understanding the Right Nature of Your Stock Options 19 Comparing Stock Options to Actual Shares of Stock 20 Granting Stock Options: Why Do Companies Do It? 21 Hard work equals great rewards 21 Building (or trying to build) a stable workforce 22 “Diverting” cash from salaries to other uses 23 Comparing the Two Main Types of Stock Options 24 Chapter 2: Taking Your Chances: Getting Rich or Going Broke 27 Making Lots of Money: The Upside to Stock Options 28 When Good Options Go Bad 30 The sad story of underwater stock options 31 Is getting in early the secret? 32 Stock Options as Golden Handcuffs 34 What are golden handcuffs? 34 Conspiracy theory 35 Why stock options go underwater 37 Reading the Oxygen Meter on Your Underwater Stock Options 38 Real companies versus fad companies 39 Realizing failure isn’t just a fad 40 Chapter 3: Knowing What Kind of Stock Option Situation Is Best for You 43 Assessing Your Attitude: Entrepreneur, Investor, or Working Stiff? 43 The entrepreneurial approach to stock options 44 Stock options as an investment vehicle 47 Job security and a steady paycheck — but with a “kicker” 48 Considering Your Personal Situation 49 The Two Different Types of Employment Situations 50 High-risk, high-reward situations 50 Risk-managed situations 50 Putting It All Together 51 Determining the Best Situation for You 52 The risk-reward balance and your share of the ownership pie 52 Considering the external environment and your personal qualifications 53 Chapter 4: The Big Guys and The Big Picture 57 Recognizing the Big Guys? 57 Board members 59 Identifying the big guys and watching their moves 60 Understanding Other Big Guy Investment Vehicles 60 Restricted stock 61 Warrants 62 Convertible debt 62 Knowing How Much of Your Company the Big Guys Own 63 The earliest stages of startup 63 After the first few rounds of investment 64 After going public 65 The Fortune 500 stage 66 The “Friends and Family” Stock Program 67 Part II: Details, Details: What You Must Know about Your Stock Options 71 Chapter 5: Deciphering the Legal Language of Stock Option Agreements 73 Knowing What an Employee Stock Option Agreement Is 73 Figuring Out What Kind of Stock Option(s) You Have: ISO or NQSO 74 Trudging Through the Details of Your Stock Option Agreements 75 The date of the agreement 76 The number of shares 77 What kind of stock 78 The strike price 79 The vesting schedule 80 Split adjustment clause 82 Knowing When Your Option Is Exercisable 84 Exercising your stock options 84 Conditions of employment 85 Termination provisions 86 Change of control clauses 87 Blackout periods 88 Replacement clause 88 Restrictions on rights 89 References to your employment agreement 90 The rest of the legal language 91 Signature blocks 92 Chapter 6: Exercising Your Stock Options 93 The Four Reasons to Exercise Stock Options 93 “Show me the money” 94 “Save the money!” 94 Diversification 95 Tax reasons 95 Procrastinators, Beware! Getting All of Your Paperwork in Order 96 The Mechanics of Exercising Stock Options 97 Be sure to write (or call) 97 What do you get when you exercise? 98 Reading the tax forms when they arrive 99 Exercising Pre-IPO Stock Options 99 How Much Money Do You Need to Come Up With? 100 The cashless exercise 100 Paying for stock with real money 101 Chapter 7: Differentiating Pre-IPO and Post-IPO Stock Options 105 What Is an IPO? 105 IPO basics 106 How about your stock options? 107 Receiving Pre-IPO Stock Options 109 Pre-IPO option pricing 109 What can you do with your stock options before your company goes public? 109 What happens to your pre-IPO options when your company goes public? 110 What happens to your pre-IPO options if your company doesn’t go public? 111 Receiving Options When Your Company Is Already Publicly Traded 114 Riding the waves: How your stock options are affected by normal peaks and valleys in your company’s stock 115 The danger point: Joining a company right after a post-IPO stock price runup 116 Chapter 8: No Trading Allowed! Lockups and Blackout Periods 119 Understanding Post-IPO Lockups 119 Getting Through Blackout Periods 121 What is a blackout period? 121 Who is subject to a blackout period? 122 What is your blackout period strategy? 122 Chapter 9: Finding Stock Option Information Online 125 myStockOptions.com 125 MyOptionValue.com 126 StockOptionsCentral.com 127 www.stock-options.com 127 MyInternetOptions.com 128 The National Center for Employee Ownership (NCEO) 128 EDGAR? Who’s That? 129 Part III: Money! 131 Chapter 10: Determining What Your Stock Options Are Really Worth 133 Valuing Stock Options 134 Knowing your options’ value: Why it’s important 135 Getting complicated: The Black Scholes Model 135 The Value of Your Stock Options at Grant Time 136 Determining What Your Stock Options Are Worth Now 138 What Your Stock Options Should Be Worth 139 Determining What Your Stock Options Might Be Worth in the Future 142 Chapter 11: Stock Options and Your Overall Portfolio 147 Counting the Baskets 147 Understanding the Principles of Personal Financial Planning 149 Considering Your Equity (Stock) Holdings 150 Investing in Your Employer 151 Buying additional stock in your company 151 Your company’s Employee Stock Purchase Plan (ESPP) 153 You’re Wealthy! But Is Your Wealth Real or Only on Paper? 157 Two different kinds of paper wealth 157 Protecting (or trying to protect) your unvested stock profits 160 Sector Exposure 161 Part IV: Pay Up! Taxes and Stock Options 163 Chapter 12: Understanding the Basics of Taxes and Stock Options 165 Deciding How Much You Want to Worry about a Tax Strategy for Your Stock Options 165 Warnings and Possible Surprises Waiting for You 167 Tax laws change frequently 167 Owing taxes even if you haven’t received any cash 168 Key Tax Concepts 168 Ordinary income 169 Short-term capital gains 169 Long-term capital gains 169 Alternative minimum tax (AMT) 170 State Tax Considerations and Michael Jordan? 171 International Tax Considerations 173 Canada 174 England (U.K.) 175 Ireland 175 France 176 Chapter 13: Nonqualified Stock Options and Taxes 177 What Is a Nonqualified Stock Option (NQSO)? 177 Understanding the Basics: NQSOs and Taxes 178 Grant-time tax consequences 178 Exercise-time tax implications when you hold your shares 179 Exercise-time tax implications when you do a cashless exercise 182 Calculating taxes when you sell shares you acquire from exercising NQSOs 184 Complicating the Situation 186 Why you might owe taxes at grant time 186 Exercising and no taxes: Delayed income recognition 187 Understanding the Section 83(b) Election 187 Section 83(b) basics 188 Section 83(b) risks 189 Section 83(b) mechanics 189 Tax Withholding and Exercising NQSOs 190 NQSOs and Your Tax Forms 191 Your W-2 (and your pay stubs) 191 Form 1040 191 Schedule D 192 Timing Troubles: When Should You Exercise NQSOs? 193 As soon as possible 193 As late as possible 194 At regular intervals 195 One more consideration 195 Another Key Decision: Which Option(s) Should You Exercise? 195 Chapter 14: Incentive Stock Options and Taxes 199 What Is an Incentive Stock Option (ISO)? 199 Talking Taxes and ISOs: The Basics 200 Grant-time tax consequences 200 Exercise-time tax consequences 201 Tax consequences when you sell ISO shares 201 Pleasant disposition or nasty disposition? 202 Disqualifying Disposition of an ISO 202 Scenario #1: You make money on the deal 203 Scenario #2: You lose money on the deal 206 More about disqualifying dispositions 206 Nondisqualifying Disposition of an ISO 207 Alternative minimum tax (AMT) considerations and exercising your ISOs: A preview 207 The Stock Option Titanic Scenario 211 Beware the Wash Sale Rules! 214 Can Section 83(b) Help with the AMT Situation? 216 Part V: Changes and Special Circumstances 217 Chapter 15: The Alternative Minimum Tax and Stock Options 219 Understanding the AMT 220 Calculating AMT 220 AMT rates 220 AMT exemptions 220 AMT deductions 221 Combining the basic calculations and rates 221 Getting Some of Your AMT Payments Back 222 State Taxes and AMT Considerations 223 Chapter 16: Acquiring or Being Acquired: Dealing with Corporate Change 225 Understanding Why Companies Sell Out 225 Seeking growth 226 Time to do something else 226 Receiving an unsolicited offer 227 Selling out was the plan all along 227 Dissecting the Deal 227 Acquisitions 227 Mergers 229 Divestitures 229 Additional outside investment 230 Cash versus stock deals 230 Private and Public Companies: The Mix-and-Match Combinations 233 Public company acquired by another public company 233 Private company acquired by a public company 234 Private company acquired by another private company 234 Public company acquired by a private company 235 What Happens to Your Options After a Change of Control? 235 The exchange rate means you get a new number of shares 235 Accelerated vesting (maybe) 236 Post-acquisition lockups 236 Sweetening the pot (or the golden goodbye) 237 Understanding the Tax Implications of a Change of Control 238 A Final Word: It’s a Whole New Ballgame After a Change of Control 238 Chapter 17: Trying to Predict What Will Happen to Your Stock Options 239 Looking at What’s Going on Inside Your Company 240 The retention and turnover picture 240 What’s the latest buzz on the company’s sales picture? 242 Watching the big guys and their (legal) insider trading activity 243 Is company management out of touch with the real world? 244 Cronyism 245 What’s Going on Outside Your Company? 246 It’s the economy, stupid! 246 Is your company in the buggy whip industry? 247 What the professionals are saying about your company 249 What the amateurs are saying about your company (and whether it matters what they’re saying) 250 Chapter 18: Leaving Your Job: What Happens to Your Stock Options? 251 Does the Reason You’re Leaving Matter? 252 Tick, Tock, Tick, Tock The Clock Is Running 252 Should You Sign a Termination Agreement? 254 Exercising Stock Options After You’ve Already Left 255 Read Your Stock Option Agreements Now! 255 What Happens to Pre-IPO Options If You Leave? 256 What About Underwater Stock Options? 256 Read Your Overall Employment Agreement 257 Beware the Dreaded Clawback Provision! 258 How Does Your Soon-to-be-Former Stock Option Package Affect Your New Job’s Compensation? 261 Special Job Change Circumstances and What Happens to Your Stock Options 262 Switching to part-time employment status 263 Switching to contractor status 263 Taking a leave of absence 264 Get the Lawyers! Lost Stock Options and Lawsuits 265 Part VI: The Part of Tens 267 Chapter 19: Special Stock Option Circumstances 269 Understanding the Three R’s: Repricing, Reissue, and Reload Options 269 Repriced options 270 Reissued options 274 Reload Options 277 Using Stock Options as Currency 281 Chapter 20: Ten Signs That Your Stock Options Will Be Worth a Lot! 285 A Steadily Growing Company 285 A Stable and Highly Qualified Management Team 286 A Very Active Board of Directors 286 Relatively Low Turnover Among Employees 287 Market-leading Products or Services 287 Returning Customers 288 Good Internal Systems and Infrastructure 288 Employee Empowerment 288 Thorough New-Employee Training Programs 289 Chapter 21: Ten Signs That Your Stock Options Will Probably Be Worthless! 291 The Serial-Entrepreneur Management Team 291 A Disinterested Friends and Investors–Dominated Board of Directors 292 A Revolving Door of Managers 292 Last One Out, Please Turn Out the Lights! 293 Rose-Colored Glasses Syndrome 293 High Levels of Customer Dissatisfaction 294 Poor Internal Systems and Infrastructure 294 Open Talk Among Employees About Leaving 294 Inconsistent Internal Communications from Management 295 A Sense of Panic 295 Chapter 22: Ten Things to Look for in Your Stock Option Agreement 297 What Kind of Options Are You Receiving? 297 Are the Dates Consistent and Logical? 298 Are There Inconsistencies in Details? 298 Is There a Clawback Provision? 298 Is There a Provision for a Change of Control? 299 Are the Expiration and Cancellation Details Clear? 299 Are There References to the Company’s Stock Option Plan? 299 What Is the Effect of a Stock Split? 300 What Can You Do and Not Do with Pre-IPO Options? 300 Are There Differences Among Stock Option Agreement Documents? 300 Index 301