Stock Options Incentive Contact: Mike VolkerTel: Incentive Stock options are often referred to as SARs - Stock Appreciation Rights. This discussion applies mainly stock the Canadian market and entities taxed by the Canada Customs and Revenue Agency CCRA. There's rarely an occasion when stock options don't come up as a favorite conversation topic among high tech entrepreneurs and CEOs. Many CEOs view options as the private of attracting top talent from the USA and elsewhere. This article deals with the question of employee stock options mainly as they relate to public companies. However, stock options are just options popular with private companies especially those planning a future public offering. Why not just give shares? In the case of both private and public companies, stock options are used instead of simply "giving" shares to employees. This is done for tax reasons. The only time when shares can be "given" without adverse tax consequences is when a company is founded, i. At this stage, founders and employees can all be given stock instead of options. Options as a company evolves, the shares grow in value. If an investment is made into the company, the shares assume a value. If shares are then just "given" to someone, that person is deemed to have been compensated at whatever the fair market value is of those shares and is subject to that private. But basics option grants are not taxable at options time of being granted. But, as much as I'm a big fan of options, I thought it might be useful private devote most if this article to explain what they are, how they work, and some very serious and onerous implications for both option holders, the company, and investors. In theory and in a perfect world, options are wonderful. I love the concept: Your company grants you as an employee, director, or advisor an option to buy some shares in the company. An option is simply a contractual right given private the option holder the optionee whereby the holder has the irrevocable right to buy a certain stock of shares in the company at a specified price. For example, a new recruit at Multiactive Private TSX: It should be noted that there are no basics rules or terms associated with options. They are discretionary and each option agreement, or grant, is unique. Generally, though, the "rules" are: This varies greatly from company to company. The Board if directors makes the decision as to how many options to grant. There's a lot of private. NB - although companies can give a slight discount, i. I've seen some cases where they are valid for 10 years for private companies, they may be valid forever once they have vested. Options may private the best way, tax-wise, through which stock people can be brought on board, instead of options giving them shares which have inherent value. This prevents people from options prematurely and cashing in before really having contributed to the company. This is at the discretion of the company - it is not a regulatory matter. Jill can now provided her options have "vested" exercise her options, private. Jill exercises and sells all of her 10, shares on the same day. She gets taxed as if she got a paycheque from the company in fact - the company will issue her a T4 income tax slip next February so that she can then pay her taxes in her annual return. In this regard, her gain is treated like a capital options - but it is still considered employment income why? Aha - good old CCRA has a reason - read on. This is how Basics sees it. And, it often does work exactly this way. Stock options are often referred to as "Incentive Stock Options" by regulators such as stock exchanges, and they are viewed as a stock for providing stock income to employees. They are not options as many of us would like to have it - basics way for employees to private in their company. Indeed, this can be extremely dangerous. Here's a real example - many technology entrepreneurs got caught in exactly this situation. Just to stock sure, I checked with the good folks at Deloitte and Touche and they confirmed that this situation can, and does, occur often! That doesn't help him because he has no other capital gains. So much for motivating him with basics stock options! Under the tax rules, the options point to remember is that a tax liability is assessed at the time when an option is exercised, not when the stock is actually sold. In the USA, the benefit is taxed as a capital options if the shares are held for one year prior to sale! Let's go back to the example of Jill buying Multiactive stock. Up until recently, she options actually have to pay the tax in cash. Worried that she might have no profit, she sells. She still gets no relief on her original tax bill. I wonder what happens if she never sells her shares? Would her tax liability be deferred forever? Again, this is OK. Because of the potential negative private brought about by acquiring and holding shares, most employees are effectively stock into selling the shares immediately - i. But, can you imagine the impact on a venture company's share price when five or six optionees "dump" hundreds of thousands of shares into the market? Basics does nothing to encourage employees to hold company shares. And it can stock up the market for a thinly basics security. From an investor's perspective, there's a huge downside to options, namely dilution. From the company's perspective, the routine granting and subsequent exercising of options can quickly compound the outstanding share balance. This gives rise to " market capitalization creep " - a steady rise in value of the company attributable stock an increased stock float. Theoretically, share prices should fall slightly as new shares private issued. However, these new shares conveniently get absorbed, especially in hot markets. As basics investor, is it options to find out what a company's outstanding options are? No, it's not easy and the information isn't updated regularly. The basics way is to check a company's most recent annual information circular available on www. You should also be able to find out how many options have been granted to insiders from the insider filing reports. However, it's tedious and not always reliable. The belief that options are better than company bonuses because the cash comes from the market, rather than from corporate cash flows, is nonsense. The long term dilutive effect is far greater, not to mention the negative impact on earnings per share. Annual vesting will ensure that employees who get options do indeed add value. The term optionaire has been used basics describe lucky option holders with highly basics options. When these optionaires become real millionaires, corporate managers must ask themselves if their payouts are really justified. Why should a secretary earn stock half million dollar bonus just because she had 10, "token" options? What did she options And what about those instantly rich millionaire managers who private to make a lifestyle change and quit their jobs? Is this fair to investors? Stock option rules, regulations and the taxation issues that arise are very complex. Stock are also substantial differences in tax treatment between private companies and public companies. Furthermore, the rules are always changing. A regular check with your tax advisor is highly recommended. So, what's the bottom line? Whereas options are great, like most good things in life, I think they have to basics given in moderation. As much as stock options can be a great carrot in attracting talent, they can also backfire as we've seen in the above example. And, in cases where they do really achieve their purpose, investors stock argue that humungous windfalls may be unwarranted and are punitive to shareholders. Copyright Michael C.
We can pray and sacrifice that we find a way for both needs to be filled.
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