Risky Business
If you are an employee with ownership in the business, (i.e., stock options, restricted stock, or RSUs), what would you like to get out of your ownership? Employees with equity compensation are compensated in two different ways, salary and equity ownership. Each form of compensation has different risk characteristics.
You probably think of risk as the possibility of loss or injury but it is really that more things could happen than actually will. When dealing with your financial situation, the loss of money and the emotional trauma associated with it can cause a lot of anxiety. You can also experience pain if you sell your interest in your employer only to watch the stock dramatically appreciate and your co-workers enjoy the spoils of that appreciation. Nobody should have to experience this kind of stress around their finances.
Steady Salary
As an employee, you receive regular salary payments. This is a very low risk as you consistently receive your paycheck and you know the value. Next year, this payment will likely increase, and it will probably increase the year after as well. This is your very stable and consistent cash inflow.
There are other employee benefits, which are forms of compensation, such as health insurance, 401(k) matching, and short-term disability insurance that reduce risk. With more low risk forms of compensation, the more risk you can safely take with your equity compensation.
Equity Compensation Variability
On the other hand, equity compensation has a much different risk profile than your salary. For instance, if you have restricted stock units (RSUs) in the company and the share price increases, your compensation increases. As long as the shares continue to go up this will be great!
But what if the share price declines? You’ll have to pay ordinary income taxes based on the higher share price when the RSUs vested but they are now worth less. The fluctuation in the share price is not as consistent and dependable as your salary.
Control and Conflict of Interest
When working at a company, you are on the inside and may think you know the risk at the company better than outsiders. Your day-to-day contributions to the company may not impact the share price of the business as much as some others. The management running the company usually makes the most impactful decisions, and they may not be making decisions in your best interest when it comes to your equity ownership in the business. So what can you do about it?
The best way to enjoy the benefits of equity ownership but also protect against catastrophic loss is to have a broadly diversified portfolio. This will move you from avoiding financial mistakes and confusion to feeling relieved and confident about your finances.
A good starting point is to think about what will make you feel worse, missing out if the company does well (and seemingly all your co-workers are getting rich) or losing your wealth because the company stumbles?
Joining a Successful Company – Still Risky?
What if you work for or join a company that has done very well? Perhaps the early employees at the business made millions from their equity compensation. What do you think about your equity compensation risk? It wouldn’t be prudent to assume your equity compensation will do the same as the early employees because you are joining the company at a different time period, with more employees, with an ever-changing competitive landscape. You probably are not going to get similar results as the early employees.
There are many types of risk in your financial profile, and these two areas are a good place to start. When it comes to risk, there is no common answer. I hope that I’ve offered you some valuable insight and helped you think through some of your risks in order to reduce them. If you still have questions or need help, I can guide you through your risk decisions.