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Speaker 1: Bloomberg Audio Studios, podcasts, radio news.

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Speaker 2: That's the way you do it.

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Speaker 3: You play.

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Speaker 4: Honey, working, That's the way you do money.

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Speaker 2: Money, That's the way you do it.

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Speaker 1: Let me tell you, guys, don't.

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Speaker 3: Equity based compensation has become an increasingly large part of

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Speaker 3: the US labor landscape, especially in technology and high growth

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Speaker 3: venture capital funded companies. I was at a recent employee

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Speaker 3: benefits conference in Silicon Valley, and I was shocked to

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Speaker 3: hear from so many corporate benefit managers that a lot

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Speaker 3: of their employees neglect to capitalize on their stock options

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Speaker 3: or other types of equity compensation. To help us unpack

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Speaker 3: all of this and what it means for your compensation,

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Speaker 3: let's bring in Joey Fishman. He's an expert in equity

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Speaker 3: based compensation and Ben's previously Portland, Oregon, and his clients

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Speaker 3: ranging from Seattle and Redmond down to San Francisco and

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Speaker 3: Silicon Valley. Full disclosure, Joey is the equity compensation expert

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Speaker 3: at my firm, and he's one of my partners.

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Speaker 2: So Joey, let's start with the basics.

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Speaker 3: What are the most common types of equity compensation plans

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Speaker 3: today that companies are offering and how do these differ?

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Speaker 4: Thank you so much, Barry. The most comprehensive, the one

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Speaker 4: that we see the most is restricted stock units, then

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Speaker 4: followed by non qualified stock option its incentive stock options.

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Speaker 4: Those three things tend to be the most frequent forms

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Speaker 4: of equity compensation that we see these days.

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Speaker 3: So rsu's ESOPs, what are the difference between this alphabet

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Speaker 3: soup of Yeah.

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Speaker 4: So ESOP actually is the employee stock option plan and

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Speaker 4: so that can include non qualified stock options or incentive

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Speaker 4: stock options.

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Speaker 2: What are the difference between those two?

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Speaker 4: The main difference between the two is that incentive stock options,

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Speaker 4: if you thread the needle appropriately or correctly, you avail

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Speaker 4: yourself to long term capital gains tax treatment. Non qualified

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Speaker 4: stock options are a little bit different where you have

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Speaker 4: to meet two different thresholds in order to avail yourself

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Speaker 4: to long term capital gains tax treatment. One basic primary way,

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Speaker 4: and that is incentive stock options are reserved only for

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Speaker 4: employees that comes from the treasury account. The non qualified

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Speaker 4: stock options that's typically given to board members, consultants, other

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Speaker 4: folks that have a participating activity within the firm itself,

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Speaker 4: but they're not necessarily an employee.

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Speaker 3: I kind of remember a story about a guy who

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Speaker 3: designs a logo for Facebook and they pay them in

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Speaker 3: stock and it ends up being worth millions of dollars.

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Speaker 3: I don't know if that sounds familiar. So look, my

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Speaker 3: firm is an employer.

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Speaker 2: We issue equity participation.

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Speaker 3: We have about thirty out of nearly eighty employees or partners.

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Speaker 3: I understand the advantage of offering equity compensation, but I.

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Speaker 2: Want to hear it in your terms.

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Speaker 3: What are the advantages of equity versus cash from a

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Speaker 3: corporate perspective.

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Speaker 4: I mean not to sound cliche, but we've all heard

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Speaker 4: the term that like culture each strategy. That is very

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Speaker 4: much the case in this endeavor. So like it sets

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Speaker 4: the tone, the right tone from the beginning. Employees are

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Speaker 4: incentivized to grow the business, you know, put their heads

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Speaker 4: down and get after it with less friction between you know,

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Speaker 4: management and themselves. So they feel like they're active participants

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Speaker 4: and growing the business and they'll be financially rewarded for

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Speaker 4: doing So.

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Speaker 3: What are the disadvantages from a corporate perspective?

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Speaker 4: They are complex to administer. The regulatory environment is kind

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Speaker 4: of a beast, and you do have to spend money

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Speaker 4: on compliance to make sure that you're threading the needle

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Speaker 4: of all the various rules that apply depending on the

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Speaker 4: various stock plan that you choose to employ.

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Speaker 3: So let's say both a company and an employee say, hey,

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Speaker 3: this equity thing sounds attractive. How do you go about

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Speaker 3: figuring out what's the right mix of equity and actual

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Speaker 3: cash compensation? How does this differ from employees at different

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Speaker 3: levels within the company.

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Speaker 4: It's more art than science, and so each company is

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Speaker 4: going to have its own version of an equity stock plan.

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Speaker 4: The Nikes of the world, they tend to get folks

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Speaker 4: that are athletes and like to push themselves. So in

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Speaker 4: some cases they they'll offer these employees incentive stock options,

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Speaker 4: which have a lot of leverage upfront. They also have

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Speaker 4: the ability to choose RSUs or restricted stock units for

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Speaker 4: folks that want to at least at the end of

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Speaker 4: the day, guarantee that they're going to have something tangible.

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Speaker 4: Other firms like Netflix, they give you the option to

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Speaker 4: determine how much of your actual co compensation that we're

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Speaker 4: going to give you each year can be dedicated to

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Speaker 4: buy non qualified stock options. Broadly speaking, you know, oil

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Speaker 4: and gas typically uses rsu's financials typically use RSA's restricted

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Speaker 4: stock awards with healthy or juicy deferred compackages. And then

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Speaker 4: tech is very much reliant on options at the beginning,

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Speaker 4: and then as the company grows and becomes more established

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Speaker 4: and switches to RSUs.

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Speaker 3: So we're talking about a variety of different ways to

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Speaker 3: implement an equity based compensation. What does this mean for taxes?

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Speaker 3: It sounds like each one of these has its own

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Speaker 3: set of tax ramifications for the employee.

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Speaker 4: They do, and it's very hard, it's very challenging to

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Speaker 4: navigate all of it. It's like playing a game of

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Speaker 4: financial twister. The goal at the end of the day

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Speaker 4: is to get yourself available so that any we realize

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Speaker 4: gains from here on out or long term capital gains

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Speaker 4: tax treatment because at least there, you know, within the

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Speaker 4: spirit and intent of the law, you have the ability

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Speaker 4: or at least some options to beat back that tax liability.

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Speaker 4: So ideally, like you're getting yourself to that place. You know,

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Speaker 4: the ones that end up being most punishing, which you know,

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Speaker 4: relatively speaking, is you know, folks that have non qualified

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Speaker 4: stock options or ISOs in the incentive stock option case,

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Speaker 4: they may fall under what's called a MT taxes, which

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Speaker 4: is it's an incredibly inpent expensive tax that's levied on

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Speaker 4: folks that is not always recoupable down the road. And

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Speaker 4: in non qualified stock options, you may just find yourself

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Speaker 4: completely in ordinary capital gain or ordinary income tax rates.

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Speaker 4: And you know, in some cases, you know, if you're

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Speaker 4: realizing a couple million dollars worth of non qualified stock

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Speaker 4: options and you live in the state of California, at

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Speaker 4: the end of the day, you're walking home with maybe

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Speaker 4: fifty cents on the dollar. The needles that have to

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Speaker 4: be threaded to make yourself available for long term capital

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Speaker 4: gains tax screaming are hard, but if you can do

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Speaker 4: it correctly, then the window opens up for your ability

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Speaker 4: to at least chip away at that tax liability and

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Speaker 4: keep more of that game. When all of a said and.

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Speaker 2: Done, huh really interesting.

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Speaker 3: Let's talk about vesting schedules and the difference between a

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Speaker 3: cliff or a graded vesting. When do these option plans

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Speaker 3: actually show up is real assets to the employee.

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Speaker 4: To the employee, that's good question. Okay, So to the employee,

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Speaker 4: they have to follow a vesting schedule, and most work

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Speaker 4: under a four year vesting schedule with a one year cliff,

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Speaker 4: which simply means that you need to stick around for

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Speaker 4: the next four years and your shares are going to

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Speaker 4: vest in equal amounts. However, nothing is going to invest

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Speaker 4: or vest for the first twelve months. That's called a cliff.

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Speaker 4: After the cliff is met, the first twelve months is met,

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Speaker 4: you then get twenty five percent of your shares. From

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Speaker 4: there on out, for the next thirty six months, you're

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Speaker 4: going to get quarterly divestitures or vesting of, you know,

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Speaker 4: a fractional percentage of the total until that remainder period

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Speaker 4: is up and the equity is all yours.

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Speaker 3: So someone who has opted for a high equity portion

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Speaker 3: of their compensation and their company does really well, and

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Speaker 3: let's just say they've won, what's the procedures from there?

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Speaker 3: How do they take full advantage, minimize their taxes and

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Speaker 3: reduce some of their concentrated wealth in a single holder.

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Speaker 4: Here's where things really get complex, and it's going to

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Speaker 4: depend on if the company is publicly traded or if

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Speaker 4: they're privately So if they're publicly that's the easier of

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Speaker 4: the two because there's liquidity when you need it. However,

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Speaker 4: as an employee, you're going to be subject first after IPO,

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Speaker 4: assuming that you're going through the process, there's going to

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Speaker 4: be a six month lock up period where you can't

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Speaker 4: touch your shares, and so typically, i mean what generally

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Speaker 4: happens is that the stock is going to sell off.

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Speaker 4: It's going to get shellacked for the next six months,

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Speaker 4: and it's going to look terrible and it's going to

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Speaker 4: feel awful. But eventually, once that six month lock up

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Speaker 4: period is over and all of the insiders have divested

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Speaker 4: their shares, then it's put up or shut up time.

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Speaker 4: So usually, like that month period is really ruling for

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Speaker 4: a lot of folks to endure. There's there's going to

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Speaker 4: be trading blackout periods that surround earnings releases. If you're

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Speaker 4: in the C suite, you're going to need to file

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Speaker 4: specific forms to make sure that there's no whiff of

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Speaker 4: insider trading. So there's there's a whole you know, patchwork

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Speaker 4: of laws and rules that you have to follow in

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Speaker 4: order to sell these shares. And so it's not as

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Speaker 4: easy as saying, hey, when it hits this price point,

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Speaker 4: I'm going to sell everything and just live off the

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Speaker 4: you know, the interest for the rest of my life.

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Speaker 4: It's it's not that easy.

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Speaker 3: Unfortunately you mentioned private versus public. Obviously it's easy if

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Speaker 3: the company goes public or if they're purchased in an

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Speaker 3: M and a transaction. Well, what happens with private companies

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Speaker 3: where there isn't necessarily a broad, deep market that's very liquid.

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Speaker 4: They call these double trigger events. So in a privately

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Speaker 4: traded market, essentially two things need to occur. One is

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Speaker 4: you need to vest, so that's the first trigger, and

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Speaker 4: the second trigger is there need to be a liquidity event.

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Speaker 4: So if there's no transaction where somebody buy shares or

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Speaker 4: you know, liquidity exchanges, you're kind of stuck there until

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Speaker 4: something happens. If at all you could, you know, theoretically,

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Speaker 4: just have a bunch of network on paper that's captive

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Speaker 4: and never gets realized because there's just no market for it.

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Speaker 2: Really really interesting. But other than that, there really is no.

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Speaker 3: Difference between various stock option plans for a publicly traded

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Speaker 3: company or for a private company.

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Speaker 2: It's just what the exit looks like.

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Speaker 4: It's mostly the liquidity constraints that are challenging for privately

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Speaker 4: traded firms and being able to realize that gain within

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Speaker 4: at least the timeframe that you hope sometimes it's just

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Speaker 4: not available to you until a flu cappens understood.

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Speaker 3: So, what are some of the biggest mistakes you see

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Speaker 3: that either corporate offerers of equity compensation make or employees

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Speaker 3: who receive equity compensation also engage.

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Speaker 4: On the employee side, over confidence tends to run rampant.

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Speaker 4: And I say this because like with our firm, like

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Speaker 4: they're coming to us after already having won the game.

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Speaker 4: So like the world with which we see is through

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Speaker 4: survivorship bias, I should say that at the forefront, but no,

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Speaker 4: they've already wonted, so they're coming to us, and among

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Speaker 4: the things that they need to immediately wrap their heads

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Speaker 4: around is the uncertainty of having to navigate the various rules.

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Speaker 4: There's a degree of overconfidence, which you know has its

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Speaker 4: own challenges that need to be dealt with, and usually

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Speaker 4: like through strategic planning and showing them you know, sequence

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Speaker 4: of risk and how this can all play out, helps

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Speaker 4: you know, dampen that down. And you know, there's resistance

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Speaker 4: to diversifying away from you know, what they've attached themselves

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Speaker 4: to for for so many years. So overcoming those things

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Speaker 4: is definitely challenging on the On the employers on the

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Speaker 4: employee side. On the employer side, it's it's the regulatory

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Speaker 4: needles that have to be threatened. It's a beast. There's

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Speaker 4: there's this fraud with litigation. Even on the advisory side,

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Speaker 4: because it involves taxes, you have to be very careful

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Speaker 4: in how you communicate things and display things so that

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Speaker 4: you're not giving tax advice when you should be strictly,

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Speaker 4: you know, relegated to financial advice. And so the employer

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Speaker 4: is also straddling that very same line. It's very unclear.

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Speaker 4: Sometimes even attorneys don't want to touch this stuff. So

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Speaker 4: let's a it's a landmine if you don't know what

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Speaker 4: you're doing.

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Speaker 2: Let's talk a little bit about psychology.

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Speaker 3: You know, every employee seems to think their stock is

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Speaker 3: the next Nvidia, when it could just as easily be

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Speaker 3: the next Lehman or ge or Enron for all we know.

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Speaker 3: How do you, as an advisor work with employees at

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Speaker 3: hot companies letting them understand all of the risks and

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Speaker 3: potential risks they're looking at.

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Speaker 4: At the end of the day, it is considerably less

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Speaker 4: expensive to lock in your quality of life by diversifying

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Speaker 4: than it is to maintain a concentrated risk in a

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Speaker 4: single security. So, and the other way to say that

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Speaker 4: is that volatility is a tax on returns, and so

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Speaker 4: once you get to a place where, look, there's thirty

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Speaker 4: five times your burn rate, none of taxes that are

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Speaker 4: sitting in your equity comp if you're not de risking

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Speaker 4: and locking in your quality of life now, you are

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Speaker 4: missing the opportunity of a lifetime. Getting them to understand

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Speaker 4: what they don't want to happen and what they want

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Speaker 4: to avoid is absolutely tantamount. And when you show them

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Speaker 4: the difference between, hey, it's going to cost you this

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Speaker 4: much to lock in your quality of life with a

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Speaker 4: diversified portfolio versus if you continue to maintain this course,

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Speaker 4: it's going to cost you thirty to forty percent more

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Speaker 4: to ensure that you're never going to run out of

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Speaker 4: money again because of the associated volatility with that single security.

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Speaker 2: Huh, really interesting.

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Speaker 3: Last question. Tell us about the most recent trends you

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Speaker 3: see in equity compensation. What is going on, especially at

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Speaker 3: tech companies and high growth firms.

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Speaker 4: They are switching to RSUs, which are the easier of

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Speaker 4: the equity comp forms to administer, and there it's a

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Speaker 4: very simple process you're going to have a vesting schedule.

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Speaker 4: It's most likely going to have a one year cliff.

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Speaker 4: It'll unfold over four years. But you know, in each

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Speaker 4: portion or each vesting schedule, you will be a lot

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Speaker 4: of the set of shares. Whatever the value is or

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Speaker 4: the trading price is at the time at your vesting,

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Speaker 4: that's what that's what your your your amount is going

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Speaker 4: to be. There will be taxes owed, but it's it's

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Speaker 4: considerably easier than having to navigate you know, incentive stock

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Speaker 4: options and a MT tax or non qualified stock options

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Speaker 4: and the margin element and all the various tax treatments

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Speaker 4: that go along with it. And so the bottom line

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Speaker 4: vary is that everyone's trying to find a way to

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Speaker 4: simplify all this. You know, after a fifteen sixteen year

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Speaker 4: bowl market, you know, a lot of the money has

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Speaker 4: been made in the option space, and now they're they're

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Speaker 4: settling in for I would say, a more mature way

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Speaker 4: of distributing income or distributing equity compensation, because with RSUs,

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Speaker 4: at least at the end of the day, you're going

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Speaker 4: to have.

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Speaker 2: Something really really interesting.

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Speaker 3: So to sum up, if you're an employee at a

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Speaker 3: company that offers you an equity part of compensation. You

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Speaker 3: should very much explore it. Speak to your financial advisor,

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Speaker 3: speak to your accountant or tax professional.

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Speaker 2: Make sure you understand the risks.

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Speaker 3: But if you've won this game, don't hesitate to de risk.

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Speaker 3: Have a more broadly diversified portfolio. Don't have ninety percent

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Speaker 3: of your entire net worth tied up in.

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Speaker 2: A single stock.

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Speaker 3: It's just way too much risky and potentially creates a

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Speaker 3: lot of downside.

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Speaker 2: I'm Barry Rudolfs.

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Speaker 3: You're listening to Bloomberg's At the Money. Both married, manymenter

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Speaker 3: school