Talk about leaving money “on the table.”
The current darling of the “Magnificent 7,” Nvidia, the microchip manufacturer that is helping to drive the AI revolution, has seen its market capitalization shoot up to $2 trillion just 180 trading days after hitting the $1 trillion mark.[1]
However, according to Nvidia’s own public filings, NONE of its executives own stock options in the company. Considering the explosion in Nvidia’s valuation, that represents an enormous lost opportunity.
If it brings the leaders of Nvidia any consolation, they are not alone. The trend in recent years among executives at both public and private companies has been to not ask for stock options or stock appreciation rights (“SARs”) as part of their overall compensation packages. Like many other companies, Nvidia has eschewed the perceived complexity of stock options in favor of time-based and performance-based equity grants. These “simpler” forms of equity compensation still allow for handsome returns and meaningful participation in a company’s success, but few alternatives rival the exponential wealth creation power of exercising an option at a low price before a stock shoots into the stratosphere.
As the opening of this article states, that represents significant money being “left on the table.”
To reverse this trend and help executives ask for and exercise the stock options they deserve, below are key considerations for executives to explore with their advisors:
Negotiating Stock Options
- Buck the trend and explicitly ask for stock options as part of overall compensation. Executives need to know that asking for stock options as part of their overall compensation should not be considered “taboo” or overly self-serving. Rather, stock options help ensure that the firm, its investors, and the executive receiving them are aligned and mutually benefit when those options go up in value. In essence, they represent a “win-win” scenario. To be clear, stock options may not always be “on the table”—when it comes to publicly traded companies, only the highest paid executives can exert enough influence to request special grants or the reopening of a stock option plan that’s already been eliminated. But entrepreneurs and executives at young companies (i.e., startups) or private corporations with aspirations of significant growth should see themselves as the main utilizers of stock option compensation. Moreover, these fledging non-publics are also more likely to grant incentive stock options which receive favorable tax treatment compared to the non-qualified stock options that are typically issued by large public corporations.
- Know the standard practices in your industry. When it comes to stock options, not all industries and sectors are created equal. In consultation with your advisors, explore what the standards are in your industry. Are stock options common practice? What quantity is typical? Again, there can be a wide variance between sectors when it comes to stock options. For example, executives in the real estate industry are generally not likely to receive stock options as part of compensation packages, whereas in the technology sector, generous stock options are quite common. Once you know what is commonplace when it comes to stock options in your industry, align your ask to that percentage. The point is don’t negotiate for stock options in a vacuum. For executives at privately held companies, push for incentive stock options, which (as mentioned above) are relatively “tax-friendly” instruments.
- Engage with legal counsel. Before finalizing your compensation package, connect with legal counsel to carefully review your options grant to ensure you are getting the best possible package. Common issues to explore include understanding under what conditions stock options are forfeited, and what happens to options if the company gets bought out.
- Have a fallback plan. If your firm balks at offering you stock options, it’s important to have a fallback plan to ensure you are compensated commensurately. Any refusal to offer stock options could be used as leverage to get more cash compensation, or better retirement benefits or a pension. Some corporate structures may even allow for tax-advantaged “profits interests” in lieu of traditional cash or equity compensation. Explore all the ways you can receive the compensation you deserve.
Exercising Stock Options
- Consult with your advising team. With robust stock options hopefully in place, the first step in exercising those options is to connect with a highly qualified tax advisor and financial planner who are experienced in executing on stock options. Yes, the process can seem overwhelming, but a talented team of advisors should be able to simplify the process and model out how and when to exercise your stock options. They should do the math to clearly present a cost-benefit analysis of various scenarios for exercising stock options, which should tell you how much and when to exercise based on different variables. The reality is most executives wait until the last possible date to exercise their stock options, which oftentimes means “leaving money on the table” by missing possible dividend payments, potentially sleepwalking into a higher tax rate, or stunting their holding period for capital gains purposes.
- Consider your overall financial picture. Once you’ve consulted with your advising team and decided on the approach that makes the most sense for you, integrate that strategy with your overall financial plan to ensure it is congruent with your goals. For example, are your gifting plans (to family or charity) impacted by the valuation of your stock options? How dependent are your retirement and future lifestyle expectations on the appreciation of your equity? What about moving to a new state (or even a new country)? These are the types of issues you should evaluate with your strategic advisors.
[1] According to Dow Jones Market Data.
