Equity – Part 2 – Stock Options
Read Part 1 of this blog series about Stock from March 14th!
Many physicians do not have stock, also called “equity”, as part of their clinical salary packages. When you transition to the pharma/biotech industry, equity is a typical expectation in the overall compensation package.
I’ll explain this topic as I know it and have experienced it – please note THIS IS NOT FINANCIAL ADVICE! I am not a financial advisor.
Equity grants you a partial ownership in the company. The goal is to align your incentives to work for the good of the company given you have partial ownership. Now, understand that the percent of ownership for an entry-level role is likely a very small percent, in the tenth of a percent type digits. This is still a significant way to potentially build your net worth.
In Part 1 we discussed Stock, also called Restricted Stock.
Today we are discussing Stock Options…
Stock Options provide the employee the right to buy the stock at a pre-specified price (this price is called the “strike price” or “exercise price”), based on market value at the time, with the hope that the stock will increase in value, allowing the employee to buy the stock at a lower (pre-specified) price and sell it at the higher price in the future. Note that just like there is no guarantee with stock (see Part 1 from March 14th), there is no guarantee the price will go up regarding the stock options either.
When you are granted these stock options (typically at the time of new employment and sometimes annually as part of a bonus), you don’t own them yet – when you buy the stock options it is called “exercising” the stock options.
Before we get into numbers, let’s also talk about vesting. Vesting is the time frame in which you have the opportunity to buy or exercise the options. Remember I mentioned that the company is giving you stock and/or stock options as an incentive to contribute to the company; thus, they are unlikely to give you all of the equity in the company right up front! The “vesting schedule” is the amount of equity that becomes yours over a specified time period. For example, many companies vesting schedules are over 4 years and might look something like this:
- 25% of the equity is yours (stock) or yours to exercise (stock options) after 1 year of employment at the company.
- then the remaining 75% “vests” in equal tranches quarterly for the next 36 months.
As usual, an example can be very helpful!
Let’s say you start your new biopharma job and you are granted 10,000 stock options.
After you are at the company for 1 year, 25% or 2,500 stock options are yours to buy (“exercise”). That leaves you with 7,500 options. In 3 months (or at 15 months of employment), 625 options (or 1/12 of the 7500) become vested, in 3 more moths (18 months of employment), 625 more become vested, and so on until you get to 48 months of employment when you are “fully vested”.
Not all companies use this vesting schedule – so make sure you understand the vesting schedule from your company’s plan.
Now, let’s talk about the potential “up-side” of stock options.
As I mentioned, the hope is that you are granted the stock options at a lower price and can in the future sell them at a higher price, making a profit.
Let’s say you start your new biopharma job and you are granted 10,000 stock options at a strike price of $5.00 per option. The “strike price” is the cost for you to buy (or “exercise”) the options.
So using our vesting schedule example above, let’s say you stay at the company for 12 months, celebrating your one-year anniversary (cheers!), and you now have 2,500 shares that are yours to buy. And lucky you, the current stock price of the company is $8.00 per share.
That means you can buy (exercise) 2,500 for $5.00/option:
2,500 X $5.00 = $12,500
BUT, the stock is now valued at $8.00/share.
2,500 X $8.00 = $20,000
So, you can profit $7.5K ($20K – $12.5K)
(Note, I’m not getting into taxes here!)
The down-side of options is that sometimes the stock does not rise in value over time. If it falls in value then you don’t lose anything with options (if you haven’t bought or exercised them), but you also don’t gain anything.
There are more complexities of stock options that aren’t appropriate for today’s blog – they involve different types of stock options (Incentive Stock Options or ISOs and Non-Qualified Stock Options of NQs). The tax treatment of these options is different and I definitely recommend when you have equity incentive, such as stock and stock options, you utilize a tax advisor.
There are some great sources of information on equity incentives including Investopedia.
Equity can be a great way to grow your financial situation but it does require some knowledge and understanding. Always ask questions and seek advice if you don’t understand!
Be Curious – it’s okay not to know something!
Ready to make a career transition to pharma/biotech… want to explore a way to use your medical training and knowledge in a fulfilling way without nights and weekends call or charting. Watch this webinar on Getting Past the Three Major Hurdles to a Career in the Pharma Industry HERE.