The Basics of Equity Compensation

When to Exercise and Sell

Good timing means knowing when to exercise stock options and when to sit on them.

Timing is everything.

When to wait

Waiting depends on the employee’s goals. Remember, stock value usually increases with time. As long as a company's future looks good, sitting on any options is probably a good move. An employee usually has around 10 years to exercise their stock options (7- and 5-year terms are becoming increasingly popular) but the company's stock agreement and plan document should always be reviewed to be sure.

When to exercise or sell

There are several factors involved in this decision, both company-driven and personal.

Diversify. This factor largely depends on risk tolerance. Most investment advisors or financial planners advise clients to have a mix of stocks, bonds, and/or mutual funds.

Company and tax rules. Employees should review the company's applicable stock ownership guidelines and IRS tax regulations. It is important to know all the rules, especially if a company requires employees to invest some of their own money in its stock and hold the shares for a specified time. In that case, the employee would have to exercise their options and sit on the shares. Often, this rule applies to executive management.

Unpredictability. If the company's stock is volatile, and an employee has a low tolerance for risk, then it may be beneficial for them emotionally to exercise and sell sooner rather than later. They have to weigh the consequences. It is important to keep in mind that the company may have rules that affect when the stock can be sold.

Risky business

Unfortunately, it is a common mistake for employees to overestimate the value of their company's stock. Failing to acknowledge the risk of stock options results in a flawed financial plan.

Diversify, diversify, diversify.

Remember, degree of diversification largely depends on risk tolerance.