Demystifying Stock Options and Signing Bonuses

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Demystifying Stock Options and Signing Bonuses
Sacha Cohen

Everything is going according to plan. You've been offered the salary you were expecting and a nice benefits package. But now, you've been thrown a curveball. Your soon-to-be employer is offering you stock options and talking about a signing bonus if you start right away. Before you jump for joy and sign on the dotted line, consider what these incentives really mean to you-in the short and long-term.

A year or so ago, stock options at many companies-especially high-tech and biotech-could mean a quick trip to easy street. Nowadays-with the stock market tumble and a slowing economy-that's all changed. And even though the economic landscape has changed, your evaluation of stock options shouldn't. Let's begin with a quick run down of what stock options are and how they are distributed out to employees.

A stock option is a contractual right granted to an individual to purchase a specified number of shares of stock of the granting corporation at a specified price for a specified period of time. The price at which the option is provided is called the "grant price" and is usually the market price at the time the options are granted. The terms of the option state the employee can buy the shares at that price for up to 10 years (the "expiration" date). Most options, however, also have vesting schedules, meaning an employee has to wait a few years before all the options can be used. Common vesting schedules are 4-5 years. Exercising an option is when an employee buys the shares he or she is offered. Sometimes they can wait as long as 10 years after vesting before they must buy or forfeit the shares.

Keep in mind that there are two main kinds of options: incentive stock options (ISOs) and nonqualified stock options (NSOs). With an ISO, if certain rules are met, the employee does not have to pay tax on the "spread" between the grant and exercise price until the shares are sold. Capital gains taxes would then be due. The company, however, cannot take a tax deduction for the spread. With an NSO, the employee pays taxes on the spread just as if it were wages, and the company can take a corresponding tax deduction.

According to the American Benefits Council about 56 percent of U.S. employers participate in stock reward plans, which cover between 7 million and 10 million workers. And even though the stock market has gone through a very rough patch as of late, that number is holding steady. In fact, a survey of consultants representing hundreds of broad-based stock option companies by The National Center for Employee Ownership found that most said that none of their clients was currently planning to alter their option plans in response to market declines.

It's important to find out how stock option grants are viewed as part of the overall compensation package, says Deborah Thobe, president of Thobe Group, Inc., a human resources management consulting firm. "Are they giving something up to get the stock -- which means then the stock represents pay "at risk," or is it "gravy" -- above and beyond the targeted total compensation for the job?"

When you are considering an offer that includes stock options, there are many questions you should ask. First, says Corey Rosen, Executive Director at the National Center for Employee Ownership, you will want to know how many options you will be getting and at what price. "In a public company, the face value of the option (the grant price times the number of options) is a good measure of initial value; in a private company, the number of options is a more useful measure." You also want to know how the company's stock price has performed and what its prospects are. Finally, you want to know if you will be getting more options in the future and what you have to do to get them.

Other questions to ask include:

-- Is the company's financial track record solid?
--How far along in the funding cycle is the company?
--How many options have been granted and at what average price? (More options could dilute the value of your shares.)
-- If the company is private, how far off is a public offering or other event that would give your options actual value?
-- What happens to your options if the company is sold?

There are a few excellent online resources where you cannot only learn about stocks, you can also research the company that you are considering joining (if it's public). They include Quicken.com, Fidelity.com, TheStreet.com, Motley Fool and Kiplinger.com.

Sidebar: Quick Tips for Evaluating Stock Options
Sidebar: Stock Options Terminology

All About the Signing Bonus

Another benefit that many companies now offer is the signing bonus, which is "a pile of cash that you get up front, just for signing on to work for a company," say the advisors from the Motley Fool. Last year, Lucent made news when it paid its new CFO $4 million just to join the company. While the amount of money is unusual, the practice is not rare at all.

Many companies use signing bonuses to attract and retain high-level executives and mid-level management, reports WorldatWork (formerly the American Compensation Association), which found that 60% of its members offer sign-on bonuses. It usually serves two purposes, says Dwight Ueda of Salary.com: a signing bonus establishes goodwill and "buys out any compensation 'left on the table' from a previous employer."

If you find yourself in the rather enviable position of being offered a signing bonus, you should ask a couple questions first. For example, find out when you'll be eligible to receive the bonus (after six months with the company, a year, immediately, etc). Generally, medium to large signing bonuses are paid over a period of up to a year to protect the company's interests. But according to the WorldatWork survey, of the payouts given, only 40 percent required a split pay (part of the money was given upon hire and the remainder was given after a set period of time). The remaining 60 percent received their entire bonus up front. You should also find out if you'd still receive the bonus if you leave the company after a certain amount of time. And, if you did receive the lump sum when you started, will you have to pay the money back if you leave in less than a year? Finally, ask whether or not the signing bonus in lieu of performance bonuses.

The key to getting the most from such benefits as stock options and signing bonuses is to make sure you ask lots of questions up front. The more information you get, the better off you'll be in the long run.

Sacha Cohen is a Washington-based business and technology writer. Her work has appeared in The Washington Post, Kiplinger.com, Fast Company, Oxygen's ka-Ching and other print and online publications. Cohen has been covering Internet trends and culture since 1996.