Tuesday, 31 July 2012

What to do when your employee share investment plan vests

In previous posts I have outlined how employee share plans work and how you can make substantial risk free profits from them.  As I also indicated I had signed up for my employers plan and would be participating in it to the greatest extent possible.

I have now reached the stage where the first tranche of shares are about to vest and I have to decide what to do with them.  It essentially come down to a few choices:
  1. Sell the shares immediately and take the gain
  2. Hold onto the shares for the long term and build up a shareholding in your employer
  3. Hold onto the shares for a short period of time to take advantage of prevailing market conditions.

Selling the ESP shares immediately and taking the gain

This is the least risky solution.  If you do this:
  • As outlined in my original posts one of the great things about employee share plans was that you get a very high guaranteed return.  It is only guaranteed as long as you sell it straight away and lock in your gain else you are at the mercy of the capital markets and the swings in value that result
  • You are taxable on the discount you receive on the stock regardless of when you sell it so selling it straight away gives you cars to pay the tax instead of having to pay out of your other funds
  • You however do lose any potential upside that you could get from buying an undervalued stock

Holding the shares for the long term

This option is the one with the most variability and has the potential for both the best and worst payoff.  Some points you need to consider:
  • If you truly understand how your employers business works and you believe that the business has good fundamental prospects for the long term then this could be a great way of purchasing a stock at a significant discount
  • Some of the wealthiest people in the corporate world have made their money by holding onto stock issued to them by their employer over many years
  • If you do this though you need to remember that this should be treated like any other investment and you have to objectively assess your employers prospects and value on a constant basis like any of your other investments.
  • A downside is that you are liable to pay the tax on the gain in the year you get issued the stock and not when you actually sell them.  Thus you need to pay thus tax out of your other earnings

Hold the stock for a short period of time
Often there are circumstances which means that it is favourable to hold the stock for only a short period of time.  This involves more risk than selling it straight away and less effort than keeping track of the business fundamentals over the long term:
  • If you work for a company that is a high dividend paying entity then you may want to wait until this dividend is paid and take advantage of the extra income.  Although share prices typically do fall after a dividend is paid the different tax treatment of capital gains and income could mean that this works in your favour
  • Often the shares will be issued well before the end of the tax year and you may want to wait until then gap is small and take any advantage of any upside price movements
  • If the shares are lifted offshore and your home currency is overvalued you can attempt to play the currency game
  • You are however exposed to movements in the share price which in the shirt term may have little to do with fundamental valuation
  • This should only be done if you have a definite strategy in mind and if you accept the risks that come making with it

Your decision all has to do with your risk profile, your belief in your company and the extent to which you believe you can do better elsewhere in the market.

Personally I will be taking the first option because I do not truly understand the state of my employers financial position and I believe there are investment options which I understand better. Further I get restricted stock as part of my compensation and believe I have sufficient exposure to my employers stock and want to diversify my exposure.

Do you hold onto stock issued to you by your employer? What are your views on he hold versus sell debate?

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