Stock Options vs Cash Bonuses: A Closer Look at Ethical and Financial Considerations

Your privately held company is offering you 1,000 shares of stock at a strike price of $10 per share, valued in lieu of a $10,000 cash bonus. While this might seem like a trick, there are several factors to consider before making a decision. Let's explore the ethical and financial aspects of this offer.

Ethical and Financial Perspective

Presuming you didn't previously agree to a cash bonus and the true fair market value (FMV) is $10 per share, this offer is ethical and might be more profitable for you if the valuation increases above $10 per share. However, there are several key points to consider:

Stock options are not guaranteed to rise in value. If the stock doesn't more than double in value, you won't see a significant profit. Compare the future value of the option with the future value of the cash bonus. If the stock more than doubles in value, the option might be a better deal. Most companies that offer stock options as compensation provide them at a strike price below the FMV, typically 15% below. You would only pay ordinary income tax on the difference at the time of sale, and capital gains on any subsequent appreciation, which can be lower than salary taxes. For private companies, the FMV is often speculative and based on the company's word. A $10 FMV does not definitively value the stock. Consider the company's financial health and prospects. If it's a promising company like Google or Facebook, the option might be a good idea. However, for most businesses, the chances of success are slim.

Reading the Fine Print

Before accepting stock options, it's crucial to read the paperwork carefully. Here are some key points to consider:

Understand what happens if you leave the firm. This can significantly affect the value of the options. Consider the company's liquidity events, such as an IPO or acquisition. Knowing when these might occur can help predict the minimum time you'll have to wait for potential returns. Question the company's cash flow if they are offering stock options instead of cash bonuses. This might indicate financial instability.

Additionally, the FMV of $10 per share is just one factor. You also need to know the total number of shares outstanding to understand your percentage of ownership. This is crucial for predicting the future value of the options.

Compensation History and Agreements

To make an informed decision, consider the following:

Were the expectations for compensation clear when you were hired? Was a written offer provided, guaranteeing cash bonuses? If you were led to believe you would receive a cash bonus and it's changed, then the ethical considerations come into play. The company might be being dishonest. However, if there was never an expectation of a cash bonus, and this offer is a generous addition, then it might be worth taking the stock options.

In conclusion, while stock options can be a more lucrative offering, they come with risks and ethical considerations. Make sure to carefully review all paperwork, understand the company's financial health, and consider the future value of the options before making a decision.