Working For A Piece Of The Action
When does trading salary for equity make sense? Here's how to do the math.
(Business 2.0) – No, the clock hasn't turned back to 1999. But with the market showing faint signs of life, employees are once again considering stock options in lieu of cash when negotiating salary packages. That, of course, brings up a tricky question: How on earth do you value options? In other words, assuming that you stay put long enough for your options to vest, how much does a company's stock have to rise to justify taking less cash up front?
Paul Dorf, managing director of consulting firm Compensation Resources, says a simple rule of thumb is that an options grant is worth about a third of its face value—the number of shares times the strike price—but, he adds, the rule is only "a modicum more accurate than spitting in the wind." And to make it even more difficult, there are other moving parts to consider:
RAISES» The amount one truly gives up expands with each raise. Over five years, the difference between starting salaries of $140,000 and $150,000 isn't just $10,000 times 5; assuming a 5 percent raise each year, it's really $55,256.
BENEFITS» The amount that employees can put into a 401(k) account—and the amount an employer will match—is generally computed as a percentage of salary. The same with most bonuses. Over five years, someone who starts at $150,000 and receives an additional 20 percent of his salary in retirement matching and bonuses ends up with $11,051 more than a $140,000-per-year employee with the same benefits, before taxes.
LIQUIDITY» That extra $66,307 is real money that can be stuffed under your mattress, deployed in the bond market, gambled on lottery tickets—or, in some cases, used to buy company stock for less than the strike price of last year's options.
So forgoing cash for options is a sucker's bet? Not always. As evidenced by the case to the right, it all comes down to the fortunes of the company. If its stock price increases by 8 percent a year—the annualized return of the S&P 500 between 1972 and 2002—the employee who decided to take $10,000 less in salary in exchange for 10,000 more options winds up about $20,000 in the hole. But if the stock rises by 12 percent a year, the same employee comes out about 10 grand ahead. As Dorf succinctly puts it, "Stock options are a crapshoot." — IAN MOUNT