Concentrated Stock: Where Company (Stock) Loyalty Can Be a Risk
By Sara Craven, CFP®
October 17, 2017
Awards of company stock in any form are a meaningful and commonplace way for employers to compensate their valued employees beyond their regular salaries. But all too often — as a result of this generally welcome benefit — we see investors accepting too much personal financial risk by carrying oversized concentrations of the common stock and/or stock options of their employer.
Company stock can be awarded in a variety of ways:
Employer Stock Purchase Plan: periodic offerings of company stock, whereby the employee purchases shares, often at a discount, to the current market price.
Restricted Stock Units: an increasingly popular form of equity compensation whereby the employee is awarded shares of company stock that vest over a set period of time.
Stock Options – either Incentive Stock Options (ISO) or Non-Qualified Stock Options (NSO or NQSO): another common form of equity compensation in which the employee is awarded the right to purchase stock at a pre-determined price. Note: there is an out-of-pocket cost to the employee to exercise these stock options, as well as various potential tax implications that need consideration.
Generally speaking, portfolio diversification is a good way to mitigate investment risk. Too much of a good thing can be, well… too much. Over the years, long-time employees may accumulate large holdings of their employer’s stock, or stock options. If they don’t practice some sort of selling discipline of at least some of their holdings after they vest — and diversifying such proceeds into other investments — employees could find themselves over-exposed to their employer’s fate. This increases the risk of suffering substantial personal financial loss if the company’s stock suddenly underperforms. Many times, the employee may simply be frozen in the decision-making process because of the complexity of these stock and option ownership methods.
The development of any sensible diversification strategy requires thorough analysis of the tax impact of selling versus the benefits of diversification, how much to divest, immediate versus staged selling, and alternatives to selling such as hedging techniques or possible direct donations to charitable vehicles. There are also differences among the types of stock options involved when considering the potential tax treatment at exercise and/or sale. It’s critical to know the difference and incorporate careful diversification planning, since there might be ways to mitigate related tax consequences. All future anticipated stock awards should also be considered in the overall analysis and planning, plus the timing of all scheduled vesting dates.
Loyalty to one’s employer or team is a typical motivation to hold onto company stock. Sometimes, a certain holding size of shares is expected or even required. If this sounds familiar, there could be creative ways to satisfy these conditions without subjecting your personal wealth to excessive financial risk.
If you have a concentration of company stock in your 401(k), there may be a solution in a strategy called Net Unrealized Appreciation (NUA).
Before selling, though, it’s imperative that you consult your company’s stock plan administrator. If you are an officer of the company, a member of the Board of Directors, or a consultant or contractor who receives access to material non-public information in the course of your work with the company, then you will be subject to certain restrictions around trading activity. You may need to seek pre-approval for trading, and/or file Rule 144A documents, and/or adhere to open trading window requirements. Great care should be taken with regard to selling any such restricted company shares in order to avoid violating federal and state securities law and company policies.
Of course, all of these potential concentration outcomes are, basically-speaking, “good problems to have”; however, consider if your employer were to give you a $50,000 cash bonus, would you simply turn around and buy $50,000 worth of your company’s stock on your own? Your answer would probably be “no”. By not routinely liquidating company stock (and diversifying your wealth) as it is awarded to you and instead allowing a concentration of stock to accumulate (sometimes unwittingly), this is essentially the same thing.
Articles and Commentary Information provided in written articles are for informational purposes only and should not be considered investment advice. There is a risk of loss from investments in securities, including the risk of loss of principal. The information contained herein reflects Sand Hill Global Advisors' (“SHGA”) views as of the date of publication. Such views are subject to change at any time without notice due to changes in market or economic conditions and may not necessarily come to pass. SHGA does not provide tax or legal advice. To the extent that any material herein concerns tax or legal matters, such information is not intended to be solely relied upon nor used for the purpose of making tax and/or legal decisions without first seeking independent advice from a tax and/or legal professional. SHGA has obtained the information provided herein from various third party sources believed to be reliable but such information is not guaranteed. Certain links in this site connect to other websites maintained by third parties over whom SHGA has no control. SHGA makes no representations as to the accuracy or any other aspect of information contained in other Web Sites. Any forward looking statements or forecasts are based on assumptions and actual results are expected to vary from any such statements or forecasts. No reliance should be placed on any such statements or forecasts when making any investment decision. SHGA is not responsible for the consequences of any decisions or actions taken as a result of information provided in this presentation and does not warrant or guarantee the accuracy or completeness of this information. No part of this material may be (i) copied, photocopied, or duplicated in any form, by any means, or (ii) redistributed without the prior written consent of SHGA. For disclosures, including additional information on credential designations of SHGA representatives please see our Form ADV Part 2A and 2B Disclosure Brochures, which can be obtained by clicking here.
Video Presentations All video presentations discuss certain investment products and/or securities and is being provided for informational purposes only, and should not be considered, and is not, investment, financial planning, tax or legal advice; nor is it a recommendation to buy or sell any securities. Investing in securities involves varying degrees of risk, and there can be no assurance that any specific investment will be profitable or suitable for a particular client’s financial situation or risk tolerance. Past performance is not a guarantee of future returns. Individual performance results will vary. The opinions expressed in the video reflect SHGA's or Brenda Vingiello’s (as applicable) views as of the date of the video. Such views are subject to change at any point without notice. You should not treat any opinion expressed by SHGA or Ms. Vingiello as a specific inducement to make a particular investment or follow a particular strategy, but only as an expression of general opinion. Nothing presented herein is or is intended to constitute investment advice, and no investment decision should be made based solely on any information provided on this video. There is a risk of loss from an investment in securities, including the risk of loss of principal. Neither SHGA nor Ms. Vingiello guarantees any specific outcome or profit. Any forward-looking statements or forecasts contained in the video are based on assumptions and actual results may vary from any such statements or forecasts. SHGA or one of its employees may have a position in the securities discussed and may purchase or sell such securities from time to time. Some of the information in this video has been obtained from third party sources. While SHGA believes such third-party information is reliable, SHGA does not guarantee its accuracy, timeliness or completeness. SHGA encourages you to consult with a professional financial advisor prior to making any investment decision.
