The Hidden Risk of Share Based Compensation - Part II
Part II - The Quick But Essential Test
You bought a racehorse and the biggest meeting of the year is coming up. Having already invested time and money into this horse, regardless of the odds and the conditions and the competition, you feel almost obliged to back it on the day as well.
Betting on a different horse would feel completely wrong – fair enough. However, it’s important you’re not also backing only one horse with your income and your portfolio.
You can control the certainty of the outcome of the race as much as you can control the certainty of the performance of your company’s stock – not at all!
That’s ok. You don’t need to. The most important lesson you’ll probably hear from seasoned investors who’ve already earned their calluses in the markets, is to control what you can control.
The really good news is what is under your control is actually what ends up mattering more than anything: your asset allocation, your diversification levels, your trading timings, as well as the fees and taxes you pay along the way.
Managing these well will remove removable risks and put you in a strong position to achieve your financial goals.
If you earn shares as part of your compensation package at work, there’s another risk to manage, and a helpful start is to run a quick but essential test.
Ask yourself, “If I was given an extra €100,000 after-tax at the end of the year as a bonus, would I immediately invest all of this into my company’s stock?”.
- If you have total faith in your company’s prospects, more than any other company in the world, you might say yes.
- If you have some faith in your company, but also have concerns about tying your compensation and savings into the fortunes of one firm, then you might still be passively saying yes out of inertia rather than conviction.
- If you maintain your company has strong prospects, but want to take some risk off the table then you might answer no, and use your bonus to buy a share of thousands of companies instead.
There’s also the, often-overlooked, element of timing. You’re earning your SBC to, at some stage, spend it.
Your company might go through a heavy drawdown (as almost every public company has) that unfortunately coincides with your house deposit or sabbatical or retirement or whatever you had in mind to fund with cashing out some shares.
Shocks to equity values don’t just happen with risky tech start-ups; many “blue-chip” employees have been through this unfortunate scenario. Goldman Sachs employees in 2008, Meta in 2022, Salesforce at the start of this year. Amazon, Citigroup, Nvidia, McDonalds, Netflix, and many more household names have experienced multiple 70%+ drawdowns.
If you have €1m in your company’s shares and when you go to sell them, they’re worth €300k, suddenly concerns over loyalty or taxes don’t seem as important.
Again, the good news is you can control this too.
You don’t need to sell all your shares. But, to reduce risks, you do need to sell some. Enough to know that you’re going to be ok if catastrophe happens in terms of loss of earnings or share price.
The best course of action is probably to speak to a financial advisor to put a tax-efficient plan in place to sell down and build a robust financial structure to ensure your money is invested according to your needs and goals.
Ideally, your advisor would have the following attributes:
- Experienced with people like you
- Conflict-free
- Control what can be controlled
At Biograph, we understand that selling down is not a reflection of loyalty, it’s a matter of risk, and that letting the tax tail wag the investment dog is not the right approach.
Unlike our advice to you, we only have one horse in the race – you. Biograph does not accept any corporate mandates, meaning we focus solely on what’s best for our clients without having to consider the incentives of the employer, investment banks, or corporate brokers.
Our investment philosophy is based around managing risks and controlling the important things. We know that, when more than half of a windfall can go to tax, what happens to that half that survives needs to be well-managed.
“Should I sell my company’s shares?”
It can be as emotional a decision as a financial one. It’s not easy to get the balance right between the upside potential, downside risks, tax-efficiency, and your own regret symmetry and quality of sleep.
If your salary and your portfolio are the same bet, you could be backing the winner, but some profit off the table is how you guarantee you leave the track ahead.