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Reinvestment in your private employer: exercising options for fun and profit

Investments are interesting beasts. An investment requires some amount of risk. That is, a percentage change that one will lose whatever was invested. In general the risk is money, but it can be time, too. The loss of money, being a physical or logical possession, is easy to conceptualize. The loss of time is not so much a loss, because time is not a tangible object that can be acquired or surrendered. Rather, time lost is simply time spent doing something that was not productive. The general expected product is, of course, money, but may also be sanity or saved time. Thus, if money is not the return of time invested, time is itself the return, in the form of not having to spend time doing something undesirable later on!

Employment is an investment of time. One invests their time, perhaps eight hours per day for five days per week, in order to earn an expected return: money. Some employers respect employees’ investment of time enough to pay the employee even when they are not working, because the employer recognizes the investment it has made in building the knowledge and reputation of its employee. Sometimes, there’s an unexpected return in addition to the agreed-upon money. An unexpected return can be knowledge, or perhaps a higher than expected compensation in the form of a bonus. Employees like employers who give bonuses.

I believe that the ultimate recognition of an employee’s time, and therefore knowledge and reputation, or really, trust, is the gift of ownership of the company. This comes in many forms, but most often simply stock or stock options. A gift of stock, or stock in place of money for compensation, is very generous and rare for a normal employee of a company. Such is generally reserved for investors and co-founders, or employees who have done something very important for the success of the company.

Stock options are more common. Instead of giving direct ownership of the company, the employer gives the employee the option of becoming a part owner of the company by reinvesting the return of their time investment: their money. In exchange for some money, the employee gains an sense of ownership of the company and some control of its future. This ownership is important because we humans enjoy a sense of possession, of ownership of the fruits of our labor.

It may be a sacrifice for an employee to reinvest in their employer. That’s understandable. However, there is another way.

If an unexpected return – a bonus – is possible, the employee should consider reinvesting that unexpected return in the employer when the employee has been granted stock options. To reinvest via stock options, one exercises stock options by purchasing stock and thus becoming a stockholder. In order to see a return on investment on stock, the company must pay dividends or exit, which means that its stockholders agree to sell the company to another, or the stockholders agree to make the stock available for anyone to purchase, and not just trusted investors or employees.

There are many things to consider before embarking on ownership.

  • Is the company profitable? The answer does not have to be yes, but a profitable company is more likely to survive to see an exit than an unprofitable one!
  • Is the product sound? If the product is in demand and its customers value it, and it’s an honest product, meaning that it’s not snake oil, then it’s more likely that the company will be profitable because it has a product to sell. Products are not necessarily goods. Products can be services, too.
  • Does the company respect its employees enough to retain the most valuable employees? A company is but a group of people. Do the people in charge of that group show the others kindness and appreciation, generally in the form of a permissive work environment or unexpected generosity?
  • Does the company spend its money wisely? It is one problem to be hemorrhaging cash or taking on debts without the employees, product, or profitability to repay said debts. It is another problem for the company to be so stingy and pennywise that expenditures necessary or desirable to keep employees happy and production positive are overlooked or ignored. Finding a balance is important, and so is understanding this question from a wider time scale.
  • How much of its market(s) does it control? A company that controls 1% of a $100 million market is a $1 million company. A company that controls 1% of a $1 billion market is a $10 million company. There’s a significant difference in the change of order of magnitude: a significant difference in the needs of the company and its employees in order to ensure a solid product and thus profitability. Does the company have a presence in the market? Is that market share growing or contracting? Is the need for the product short term or long term? Is the market going to disappear in a few years because of overall falling demand even though the company’s market share is growing?
  • Does the company pay dividends to stockholders? Dividends in small companies are rare, as it is often more valuable for the company to spend its money on its employees who are not stockholders or on building its business via marketing or additional product lines. However, a dividend is money returned than can be again reinvested in the company. It can also be invested in something such as a cold beverage or relaxing vacation, or saved for when one does not need to work! That’s called retirement.
  • What are your financial goals? Is the value of saving unexpected income for retirement or another major life event – or even just paying the bills – more valuable than the potential return if the company exits?
  • How will the company exit? Is it more likely to be acquired by a larger company, or will it go public? If there is no exit and there is no dividend, there’s no return on the investment. Of course, either of those can change at any time, but of course, it’s important to balance that chance with the chance that the income can be better spent elsewhere.

My previous employer exited by selling to a larger company. I foresaw such an event and opted to reinvest a portion of any unexpected income in exercising my vested stock options. Vested means earned and available.

The return was worth it. Why? Taxes.

The sale of stock held for a certain period of time is taxed at one rate, while the conversion of options to sold stock at sale time is taxed at a higher rate. If I’d exercised options that were vested but not yet exercised, my return would have been even higher. If I had not exercised vested options, I would have some money – which would likely have been spent on other things – and my option would have yielded far less return because of the difference in tax rates.

I urge any person offered stock options to consider heavily exercising them if the health of their company is good.

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