The Equity Comp Mistakes Most Executives Make (And How to Avoid Them)

Quick question. When HR sent you your last equity award, your RSUs, your options, whatever it was, did you actually read the whole thing or did you look at the headline number, feel good about it, and move on?

You know, most executives engage with their equity comp the way most people engage with their phone bill. I mean, they know roughly what it is, they know it matters, and they've never actually sat down and understood it. The difference is your phone bill isn't going to determine whether you retire when you want to.

And today we're changing that. We're going to walk through what your equity package actually contains, what it actually costs you, and what the decisions are that most executives get wrong every year that are completely avoidable if you know what you're looking at. Let's fix that. So quick intro. I'm Brian Dress, Director of Research here at Left Brain, also an advisor. We're an independent wealth management firm here in Naperville, Illinois, and we work specifically with corporate executives on equity compensation and overall financial planning. With me, as always, is our CEO and Chief Investment Officer, Nolan Langford. Nolan, welcome to the program and introduce yourself for anyone who's new here.

So my background is in fundamental research. You know, equity comp is one of those areas where the details really matter. And I spent a lot of time understanding how it actually works.

And today, what the different types of equity comp really are, what happens at vest, and why that moment matters more than most people realize, and how to start building a real plan around all of it. If this is all useful for you, hit subscribe. We put this type of information out regularly. Let's get into it. So, Noland, let's start at the beginning, because even executives who've been receiving equity comp for some time, for years, often have a fuzzier picture of what they actually have than what they'd like to admit to you. Walk us through the main types of equity comp and what actually makes them different.

So I'm going to break this down. There's 3 main types of equity comp. We'll go with the one that started first, which was stock options. So an employee can get a grant and that says if this— it grants them a certain amount of shares if and when the share price reaches a certain level. So imagine I get stock grants, my stock's at $100 and let's say my strike price is $125 and let's say I get 100 shares. So once that share price crosses $125 or more, then I can actually exercise that grant for 100 shares at that predetermined $125 stock price. And I would say this type of grant has more leverage to the upside in it. And that's— Security number 1. Security number 2 would be restricted stock options. And these are actually shares that come to me, except for there's certain dates when they actually become mine. So they're granted on a certain date and then they have a vesting. And then once it vests, I own those shares. And then the final type is employee stock purchase plan. Generally, this is an incentive that a company will give me as an employee that I can take money from my paycheck and purchase the company stock. Now I could always do that. So what would make it special? Well, they give me an incentive to do so. Most companies do in terms of a discount. And so I can buy the shares at a certain percent below $0.100 on the dollar, and then I can decide later whether I want to hold those shares or sell them. Okay.

And we're going to talk about some of the different details on all these different packages. They're all different. They all have different characteristics and different things you need to know and different costs associated. So we'll get into that today. If any of If any of this applies to you, hit like and share this with your colleagues. It's definitely information that you need to know and that your colleagues need to know as well who are involved in these different types of employee stock purchase plans and equity comp. So let's talk about some of the nuts and bolts here, Nolan. So vest day, let's talk about what happens at vesting because most executives just treat it like a routine calendar notification, just comes up on Outlook, lets you know it's vest day. It's really not just that simple. So walk me through what vest day really means and what executives need to know about when their equity comp vests.

Yeah, you're right. So vest day is really important. And I would say the 3 types of securities we spoke about, it's really only relevant for the 2, which is stock options and restricted stock units. Employee stock purchase plan, as soon as I, you know, hit the button and the plan executes, then they're mine. But for the first 2, the restricted stock and the stock options, Vesting day is important. In the case of my restricted stock units, I could get issued shares. Let's say I get issued 300 shares and there's a 3-year vesting. So that means every year, in my example, 100 shares become mine. The vesting date is the date they become mine. And it's generally, you know, 1 year from the date of grant, 2 years from the date of grant, and 3 years from the date of grant, in my example with a 3-year. So that vesting day is really important. They grant 'em to me, I can't go out and spend the money, but on vesting day they become mine. And if I want to, I could sell those shares and actually take cash. So it becomes really important. It's also important from the tax perspective. On vesting day with restricted stock unit, the day that it vests is the day it's ordinary income to me. So I know I have a tax obligation in that tax year. With the second type of security, which are stock options, vesting day isn't so important. I mean, it is important, It's the day that I can actually exercise the option and take action on it. But the vest day does not trigger a tax responsibility to me. But my example I used earlier, they were granted at $100. At $125 or higher, I can exercise those as long as I've been vested.

Okay.

So it becomes really important in both of those securities for those reasons. Okay.

So you talked about that. It's definitely important. So on the flip side of that is there's mistakes that can be made in terms of managing your equity comp around vesting. So what are some of the expensive mistakes that you've seen executives make around vesting and vesting day?

So I do think you need to have a plan. And we often talk about it depends, you know, if you're in a security that's going up, you might treat vesting day quite differently than somebody who works for a company where the security's been going down. Okay. So it's really— you have to really be careful, particularly as it relates— so there's two things you have to be careful about for vesting day. One is, remember, for restricted stock units, vesting day comes with a tax consequence. So you just want to be cognizant, you know, if I've never gotten stock options before and let's say I earn $100,000 a year and that's generally my taxable income base. If this is the first year of vesting for restricted stock units and that vesting is a big number, let's say it's $25,000 or $30,000, it may move me into a higher tax bracket for the upcoming year. So I would want to pay attention to that and maybe model that out with my accountant and see if I need to do any extra withholding to pay the tax bill in April. That becomes really important. So I wouldn't say that was a mistake, but certainly something you want to be aware of. I would say the mistake could come in as I do need to make a decision on vesting day with my restricted stock units. Either I decide I just want to hold, even though it's taxable to me, I just want to hold the shares I don't pay taxes, but I'll hold the shares. I need to decide whether I want to sell the shares. And so a mistake could be just not making a decision at all when you should make a decision. Even if you hold it, it should be a conscious decision. I'm going to hold and I should have some plan on I'm going to hold until this happens, whatever that trigger is. Okay. And I would say in the case of stock options, it would be a similar thing. The mistake here could be more costly, you know, with restricted stock units. I don't really have any decision to make. You know, at vesting day, the rules say that whatever I vest at is going to hit my 1040.

Right.

So there's nothing, nothing I can really do. In the case of these stock options, there is, you know, I could do something to make myself worse off. At vesting is when I'm eligible to either, you know, to liquidate the stock or exercise and hold. And so I really need to be careful on vesting day that I make the right decision on vesting day. It's not— doesn't trigger a tax obligation like the restricted stocks did. So I need to be really conscious when I trigger that decision because it'll have tax implications.

So kind of everything that underpins what you just said is you've got to have a plan, because if you kind of go into this blind and don't have a game plan, that's when mistakes can certainly be possible in this context. So as you said, you've got to make a decision, especially on restricted stock units, whether to sell or hold. And that requires some analysis and thought process behind it. That's certainly something that we can help clients with. Let's talk about things that kind of blindside people, the hidden costs. So we know taxes are coming. You just kind of explain how taxes work with restricted stock units and options. But what are some of the things that come up unexpectedly and tend to hurt people the most? What are you seeing in practice as far as that goes?

So there's a few. One is, you know, we talked about the tax implications. So there's a wealth— there's a withholding gap at vesting, meaning that in my restricted stock units or even my stock options, there's going to be a withholding that happens. But it's, you know, the employer decides at which rate that that tax is withheld. Okay. So they can actually withhold at one rate, but that may not be my actual tax rate.

Right.

So I have to be really careful if they under-withhold. There could be taxes and penalties for me when I file if it's substantial.

Okay.

And then the other thing could be true if they're hiring, if they're withholding at a much higher rate than my actual rate, maybe I could do some other adjustments throughout the course of the year. So I'm not giving the government a tax-free loan.

Okay.

So I definitely want to pay attention to that. That difference could accumulate over multiple vests across the years, and it could be a big tax bill due at filing. So you really want to be careful. The other mistakes that we see is people selling concentrated stock without a plan. Okay. You know, executives who finally decide to sell a large appreciated position, they often do it reactively. You know, there's something going on in the market, there's some news story, something's happening temporarily business-wise at the company, either good or bad. And it makes me decide to sell based off of what's happening at the moment. That may not be from a longer-term perspective. It may not be in my best interest to do so. So that's something that investors really want to take care of. You know, a more deliberate approach where we spread across time or coordinate with other income events, that might be a more robust plan. And then there's also state tax complications. You know, Brian, we're hearing more and more about these states becoming very punitive about their most successful residents.

Okay.

So if you have a lot of money or a big net worth, a lot of these states are running deficits. And they're looking for ways to plug holes, right? They're looking for new sources of revenue. So state tax complications, you know, let's just say an executive work remotely or they travel for work. There may be tax obligations in multiple states, uh, depending on where they worked when the equity vested or when it was exercised.

Okay.

So that's something you want to pay attention to, especially as, um, remote work proliferates. And again, states are looking for revenue sources, so they'll be turning over every stone to make sure tax compliance is high.

So I know that obviously a lot of times people just don't want to pay tax today and kind of want to push it off. So what you just mentioned about what's going on with some of these states may make the decision a little bit more urgent to sort of sit down, put a plan together, and have a sense of what you're going to do at least kind of the next couple of years in anticipation of that as well, possibly. Let's talk about also the job change trap. So you've talked about this on previous videos sometimes, Nolan, is that there are some mercenaries out there that get, you know, get some stock at one place, get that equity, move on to the next. And so that does create some complications as well in that particular situation. Can you talk about some of the complications that might be for someone that's in that situation?

I think executives switching jobs really want to be careful. We talked about vesting earlier. And so when I'm given these equity grants, whether they're stock options, restricted stock units, and even in the case of an employee stock purchase plan, there are dates that are important for vesting. So they may grant it to me, but it may not be mine to keep until a certain threshold is hit. That threshold is usually a date.

Yeah.

So if I'm switching jobs often, I really want to pay attention to that date because before I go to job number 2, I want to make sure I get it. I get vested at job number 1, or else I could be leaving money on the table.

Okay. So being strategic in that situation, certainly important and I would think some of the people who are in that situation are strategic in that way, but we want to make sure if you're, if you're in that situation, that you do consider the consequences of those actions.

I would also say, Brian, when you move on to job number 2, it is the case that if you have equity comp that you're leaving on the table from job number 1, that's something that you may want to negotiate into your new pay package so you're not being disadvantaged when you leave.

So that's smart, Nolan. Part of what we do here is, of course, helping people deal with the securities that they own, these pay packages that they have, but also kind of when they move to another job, definitely want to loop your advisor in on any of these discussions and make sure that you're not leaving something out in those negotiations.

Okay.

And let's talk about options too, Nolan. Now, we know options are a little bit less widespread than they used to be. That used to be back in the '90s, especially there you would see a lot of stock options out there. Now it's mostly RSUs, restricted stock units. Those employees who are higher up in the corporate structure sometimes still do get stock options. So let's talk specifically about options, Nolan, because they do require a decision. You know, RSUs, you could in theory just let it sit there and let it run and nothing really happens. But options do require an active decision or sometimes they expire worthless. So what executives need to understand in terms of options?

You know, this is really important. You're right, Brian Dress, CFA. They're not issued as often. You know, it used to be this was the employee golden handcuff of choice for most corporations, for most employees until about the early 2000s, early 2000s, the tax rules were changed and now they have the expense. And so it hits the earnings per share in a really tough way. And so a lot of companies have moved away from so many stock options and which is why you see more restricted stock units now. So you don't see them as often, but you do still see them. And especially when you get higher levels in the organization, you see them quite a bit. I would say it's really important because there's a binary outcome when you're dealing with stock options. And what I mean by that for the viewers is at one price, my stock has options, has my option has value, but could be at a dollar less, it has no value. So earlier in the series, we talked about I, you know, I started at this company, the shares are $100 and my options get granted at $125 as my stock strike price. So if my stock price ends up at vesting at $126 a share, my stock option has value. But if it ends up at $124 a share at vesting, it really doesn't have much value because it's below a stock price. So you have to be really, really careful on exercising. You know, if we get to vesting date and the shares are at, let's say, $150 and I have that $25 per share equity, I need to decide, do I want to take that now or do I want to roll the dice forward in hopes that it gets to $200 before it goes to $100?

And then let's talk again about job change urgency here, Nolan, because For those of you out here who do have options and are thinking about leaving, how does that change the urgency around the options?

So you're right, Brian, that just makes that decision that much more crucial. You know, these options are issued and then they're issued with a 10-year expiration value. So they're generally good for 10 years. So if I'm at the company, my vesting's a 3-year vesting, I mean, that's— I mean, you're number 4 or 5. Even if my stock's below the strike price, if I continue to work there, I know I still have 5 more years, right? So I have some time. But if I leave, then I don't— you know, my options are gonna— my options are gonna go away, right? So the date I take that job offer and negotiate my start versus my exit could be a really important deal, because every day that the market's open, you know, that stock value changes, my option value changes. So if I'm close to that number or if the stock has either gone up a lot recently or down a lot recently, that will probably impact my decision.

So just in terms of a job change, your window is tight. That's basically what you need to know. And you need to make a decision quickly, not rashly, but quickly. And then let's talk about what we call underwater options, Nolan. So you mentioned that. If the stock is trading below that strike price, those are what we call underwater options. So what do you think about those people out there who are holding underwater options? Are there any kind of rules of thumb or tips for people in that situation?

That's the worst possible situation to be in. Let's imagine you're at Company A and in our example, you know, the shares are 100, my strike price is 125. And let's say the stock price is 90. You know, that's depending on the stock in the sector. Maybe you're more or less depressed than other sectors. If I'm in consumer packaged goods, which is typically a low volatility industry, which means the stock prices don't move up or down that much, right, then that $35 gap is huge.

Yeah.

You know, typically those stocks don't move that much. But if I'm in some area of tech where a $35 move is commonplace, I will have a different outlook on that. So the price, the characteristic of the stock or the company that I work at, I need to know that, you know, if I work at a pharma company that doesn't move that much, I'm going to think about my stock options differently than if I work for a chip company or a software company.

So let's kind of bring it all together and it's all about having a plan in place, Nolan. So any of these discussions or topics that we have, it really comes back to having a game plan because if you don't, you're going to make bad decisions. So by now, people that are out there watching who have restricted stock units or stock options and/or they've probably got a list of things that they know they haven't necessarily handled in the most optimal way or correctly. So what is a real plan around equity comp— compensation look like for someone who's in that situation, who knows they've got a lot of equity comp, but they don't have a plan in place? How does that start? What is the, how does that conversation begin?

So I think for, I think what's a really useful way to think about it is to, you know, we talk about building that, you know, a custom retirement income plan or the custom financial model. We think each executive should have one of these. It should be unique and custom. To their family, their lifestyle, their spending habits, their desires, their lifestyle choices. And then we're going to have a net worth statement. We're going to have an income stream flowing in, and then we're going to have a model over the course of their life. And so when you— the equity comp is certainly a piece of that puzzle. We want to look at the characteristics of it, how much or what percent of their overall net worth it represents. And that helps us decide whether this is a big decision or the decision is a little bit smaller, it's not as crucial. So you certainly want to take stock of all that. I think at the end, a plan is good. What I've seen often, Brian, is executives, they do make moves with their company stock, but it's not based off some sort of a long-term comprehensive framework. It's, you know, hey, I'm getting ready to buy a new car. I need $100,000. Where's a place I can get it? Oh, my stock options. Best, let's use that. You know, hey, we're going on vacation. The family of 4, it's going to cost us $30,000 this summer. I need cash. Where can I get it? Oh, I got these RSUs that vested last year. Let me use that.

Okay. So you're saying that's not the way to go.

Okay.

So just a couple of things. If you're in that situation, you've got all this equity comp and you haven't done anything yet. What's kind of the first thing? What's the first step to take tomorrow?

So I would gather all of my documents. You know, all these plans are different. They're generally sitting in a different HR portal. The summary plan description, my statement of what I own, my stock options or my RSUs with my vesting schedule. I'd like to gather all of that so I can have it in front of me first. Okay. And then I want to reach out to a professional and have a conversation.

And then related to that is how does someone know that they're in the situation where they need to bring a professional in for help?

I think if you're dealing with equity comp of any sort where they're giving you shares, whether it's a private equity firm that's privately owned or public firm, and you've started there and you've been there for a while and these are grants you're going to continue to get, then I think you're already, you know, anytime you're getting these stock and stock options, you're already at a level where you should be engaged with a professional.

Okay. That's pretty simple. So if you've got equity comp and it's starting to build up there in your accounts, definitely reach out. We're happy to speak with you and see if we can help. Any final notes, Nolan, for people in this situation? I know it's a good situation to be in, but do you have any final thoughts for people who find themselves in this situation?

Yeah, I would just remind people that the company that you work for, you know, kudos to them for allowing each employee and each executive to participate in the success of the corporation. I think that's worthy of being applauded. But for the employee, that comes with a certain amount of responsibility as well. You have to remember the company is making these plans available, but they're not giving you advice on what you specifically should do. So you need to go to someone as a source, a source of truth to work with you independently on your side to see what strategies you should take to sort of maximize this opportunity. And so that's the takeaway. I'd like people to be a lot more proactive Understanding that if you work for an innovative company that has a good product or a good service and business is going well, then this could impact you positively from a net worth statement in a real positive direction if you handle it right.

Absolutely, Nolan. And we've got a couple of videos out. If you're in a situation where your stock is up quite a bit, we've got a video for that. And if you're in a situation where your stock has fallen quite a bit, there's a video for that as well. So We've got you covered no matter what situation you're in. If you've been sitting on equity comp package, you've not fully mapped out, you're not alone. This is genuinely complex and most executives are navigating without the full picture. I'm Brian Dress at Left Brain Wealth Management. The first thing we do with every executive client is build that complete picture, all grants, all types, all in one place. As Nolan said, gather all the documents together and we'll put the whole picture together. Book 30 minutes with me and we'll put some clarity to your situation, see if we can help. There's a link in the description below where you can set time with us on our calendar and speak about this in more detail. We've also got an ebook out there for you. For those of you who do have equity compensation, we've got our free guide, The Executive's Guide to Managing Company Stock. It's linked below as well. We've got some tips and tricks on how to manage your equity compensation. Also talk about some of the different types of equity comp and some of the consequences, tax and otherwise, that go along with those. So take a look at the e-book. It's a good starting point to kind of educate yourself. And then we'd be happy to speak with you after and talk in more detail about your particular situation. We want to thank everyone for being with us here on Fundamentals of Investing today. Thank you, Nolan, and we'll see you next time.