In Biotechnology, attracting the right talent pool is crucial. Therefore compensation earned in either company stock or options to buy company stock offers great opportunities for these skilled employees.
We are seeing a vast majority of Biotech companies offer stock-based compensation as benefits, particularly Restricted Stock Units (RSUs) and Employee Stock Purchase Plans (ESPPs). The main question regards how employees should manage these complex options for maximum benefit. The talent behind the company’s growth stands to benefit tremendously from understanding this more in depth. To address this, let’s review how these benefit plans work.
How RSUs Work
An RSU is a form of a stock option offered to employees as a performance incentive. RSUs are designed to incentivize employees to have longevity with an employer, as well as being invested in the company’s growth. RSUs are essentially a grant of stock ownership, which becomes available to employees based on a vesting schedule.
Employees receive RSUs on a grant date. To demystify this process further, this is actually when the company pledges the shares with the promise to issue actual stock to you on a future date. So it is: grant date, which names the date to issue actual shares, then the date of receiving the shares themselves, which is the vesting date, the shares are restricted and cannot be sold.
This is based on a schedule dictated by the company, which can be based on length of employment or performance objectives being met. Vesting can occur all at once or as a percentage over time. When the shares do vest, even though an employee is being granted them, it is treated as a stock purchase in the eyes of the IRS and you now own the shares outright at the price on the vesting date.
Because RSUs are a form of compensation, you are responsible for taxes on their value as of the vesting date. For example, if your shares on the vesting date are valued at $5,000, that amount is added to your taxable income and taxed in the year it is received. In most cases, the company will withhold taxes on the vesting date. Here is where an understanding of being ready for tax season can help an employee in the long run. For example, if an employee held on to their shares for more than a year, and they appreciate in value, that person will pay more favorable capital gains taxes on the increase in value. Or if an employee sold the options right away, they could avoid the risk of the stock decreasing, but would also have a higher capital gains tax bill to be mindful of right away.
What’s the Best Way to Manage Your Stock Benefits
As everyone’s circumstances are different, there is no one right way to manage these stock benefits. However, there are certain risks that apply to everyone. The best way to manage your stock benefits is in the context of your personal financial circumstances, needs, and goals. In other words, the benefits should be managed as if they were a part of an overall investment plan with consideration for your investment objectives and risk tolerance. So, what are the risks associated with these stock benefits?
Concentration Risk
Concentration risk comes from allocating too much of your money to too few investments. A sound investment plan requires broad diversification to minimize the negative impact of any one investment on your portfolio. Investing too heavily in a single stock, rather than a diversified portfolio of stocks, exposes you to the volatility of that one stock. Not to mention that much of your financial well-being is vested in the company – your future earning, benefits and retirement savings. So, by investing in the company’s stock, you have literally put all your eggs in one basket.
Does it Make Investment Sense?
To make a sound judgement on whether it makes sense to invest in your company’s stock, consider this: If your company gave you a cash bonus of $25,000, would you invest it all in your company’s stock? Unless you have some sort of inside information (which would be illegal) that your company’s fortunes are most certainly going to soar, you probably wouldn’t. Taking a lesson from the pages of history, consider the tens of thousands of employees of formerly high-flying companies: Enron, Radio Shack, and Lehman Brothers, who lost their life savings when their employers became insolvent. The decision as to whether to sell or hold on to RSU or ESPP shares should be considered in the context of how it fits into your long-term financial objectives. In most cases, you are better off controlling how your money is invested. It may be more advantageous to move that money into a Roth IRA or a 529 College Savings Plan. If you are uncertain, meet with a financial advisor to help you determine the best way to allocate your money.
But What about Taxes?
Yes, you will owe taxes when you sell your shares, but with RSUs, you will owe taxes the day they vest anyway. With ESPP shares, you will owe taxes on the discount regardless and if you have a gain, it will be taxed at the more favorable capital gains rate. In either case, you still come out ahead with a nice return on your money. With careful management, these benefits can help with a down payment on a home, pay off student loans, fund children’s future college expenses or boost retirement portfolios.
Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual.