The term employee stock option (ESO) refers to a type of compensation granted by companies to their employees and executives. Rather than giving the employees shares of stock directly, the company gives them the option to buy stock at a lower price than what the market commands.
The employees have the right to buy the company’s stock at a specified price for a finite period of time. Terms of ESOs will be fully spelled out for an employee in an employee stock options agreement.
ESOs are subject to a vesting period. The vesting period is the length of time that an employee must wait in order to be able to exercise their ESOs. Why does the employee need to wait? Because it gives the employee an incentive to perform well and stay with the company.
There are two different financial benefits to employees for a stock option plan. First, the employee can buy shares of stock in the company and, as the company grows and succeeds, the employee will have an ownership interest in its expansion. Second, employees can buy the stock at lower than market price, then turn around and sell it on the open market for a profit. An example:
Pat works for MegaDelta Company. As part of the employment compensation package, Pat is given the option (right) to buy 100 shares of MegaDelta for $20.00 per share. At the time Pat accepts the job, MegaDelta is trading at $15.00 per share on the stock market, so Pat won’t exercise the option or buy any shares since Pat would lose $500.00 ($5 per share).
However, after Pat has been working for MegaDelta for 5 years, MegaDelta’s stock is trading at $25.00 per share. Pat exercises part of the stock option and buys 50 shares of stock, spending $1000.00 (50 shares at $20.00 per share, the option price). As soon as that is accomplished Pat sells the shares on the open stock market for $25.00 per share, for a total of $1250.00 (50 shares at $25.00 per share). Pat has gained $250.00. Pat saves the remaining 50 shares to which Pat is entitled just in case the stock price goes up more, and Pat can make even more money.
What Are the Benefits of Stock Option Plans?
For employees, the key benefits of any type of equity compensation plan are:
- An opportunity to share directly in the company’s success by owning stock
- Pride of ownership. Employees may feel motivated to work productively because they own a stake in the company
- Provides a perceptible demonstration of how much their contribution is worth to the employer
- Depending on the plan, it may offer the potential for tax savings upon sale or disposal of the shares
For companies, the benefits of a stock option plan include:
- It is an important tool to recruit the best and the brightest in a global economy where there is worldwide competition for top talent
- Boosts employee job satisfaction by providing lucrative financial incentives
- Encourages employees to help the company grow and succeed because they can share in its success
Can I Get a Portion of My Spouse’s Stock Options in a Divorce?
In a divorce, stock options can be divided in a similar manner to pension plans depending on whether your state is a community property or equitable distribution state. If your spouse has earned stock options during your marriage, most courts will award you at least a portion of the options, or their equivalent value, in the event of a divorce.
Since stock options are different from other forms or property (i.e. most cannot be exercised immediately on issue) many states do not have set laws defining how to determine the precise value of stock options in a divorce.
How Do Divorce Courts Typically Determine The Value Of Stock Options?
It is rarely a straightforward process to value and divide stocks and stock options for a divorce. Stock options may not have a cash value today, but, depending on the success of the company, the options could provide a nice nest egg down the road. This uncertainty makes it hard to put a value on them. Sometimes options are non-transferable, so simply dividing them between the two spouses may not work.
Before you agree to a division during settlement talks, you should discuss your choices with a divorce attorney familiar with high-asset and complex divorces. In many cases, your attorney will recommend a forensic accountant. A forensic accountant can handle tasks such as valuing stocks and stock options and explaining your best options for getting the fair division you deserve.
Different options allow you and your spouse to split the stocks you own together or the shares that one of you own but that are joint marital property. These options include:
- Exercising the Options. Exercising the options and then selling the stocks and splitting the proceeds seems like the easiest solution, but many people would rather keep their investments. Selling your shares can also have tax consequences that most people would rather avoid if possible.
- Buying out the Options: When one person holds stock or options in their own name because they were received as a work benefit, the options may still be marital property (that is, it belongs to both parties) because it was earned during the marriage. When this occurs, they may not want to liquidate the stock or give it away, especially if they are still with that company.
- When this occurs, they may be able to pay a cash value for their spouse’s share or offer them other assets to offset keeping all stock shares. This method requires you to first put a value on the stock holdings, which may need a forensic accountant or another expert.
The valuation of stock options is generally determined by the basic equation that is given in the option agreement between the spouse who has them and the company that they work for. Depending on the terms of the stock option agreement, courts use differing approaches to calculate the value of stock options in the event of a divorce:
- Agreements containing a formula for determining the value of the stock options: In these cases, the value will be the difference between the price at which the stock could be purchased by exercising the option and the market value of the stock as of the date on which the option is exercisable. Depending on your state, the market value of the stock will either be its price on the date of the divorce trial or its price as of the time of the divorce decree.
- Agreements not containing a formula: States also differ on how to determine the value of the stock when there is no formula expressed. Some states will find that the value of a stock option is determinable from the price of the stock, while others may find that there is insufficient evidence to determine the exact value of the stock option.
Do I Need An Attorney To Help Me Obtain My Spouse’s Stock Options In The Event Of A Divorce?
Measuring the exact value of stock options that have not yet been liquidated (i.e. converted to cash) for the purposes of asset distribution between spouses can be extremely confusing.
Having an attorney experienced in family law to assist you with a divorce is absolutely necessary. Make sure that you tell your divorce lawyer whether or not you or your spouse has stock options.