An increasingly common form of employee compensation is the stock option – the right to ownership (stock) in the company. Typically, the longer an employee works for the company, the greater the number of stock options the company will give to an employee. Some stock options can be exercised at any time (unvested) whereas others require a certain amount of time with the company before they can be exercised (vested).
How do stock options work? Some companies will offer a certain number of shares at no cost to employees as they accrue service years. Other companies will offer shares at a heavily discounted price. Once vested, an option becomes the opportunity to sell shares of stock in the company. Some options may be exercised (sold) at any time, some in a particular window of time, others only after a certain date, often dependent on years of service. The value of the option fluctuates because shares of stock go up and down with the market. In startup companies, it is likely that the stock option has its greatest value at the initial public offering, at least in terms of risk – demand will be high with the excitement of a new rollout. But as time passes, the stock will drop if the company does not meet expectations. So the longer an option is held in a startup, the greater the risk its value will drop. But just because the price fluctuates over time does not mean the option cannot have a concrete value on a given date – it is simply the price per share times the number of shares.
First, a spouse at the time of divorce holds options that can be exercised immediately. The value of the options would be the market price on the date of divorce times the number of shares obtained during the marriage, and the other spouse would have a half interest in that sum. That spouse could claim that interest either in a cash payout at the time of divorce or a transfer of half the marital share of the options. If the spouse has a pressing need for the money, taking the option as cash might be best, but that spouse would be wise to ask for the value in a way that avoids a capital gain tax.
If the spouse believes the stock has a good chance of increasing in value, taking the shares would make better sense, but still carries the risk of a downturn.
Second, a spouse at the time of divorce holds options that have not yet vested. Even though not yet ready to exercise, these options have value, or at least potential value, as they depend on the continued employment of the spouse. A cash payout here is much more speculative, particularly when the vesting is years away. A risk averse spouse may just want a buyout, and that may please the other spouse as well because that spouse could leverage a value of the option for other assets in the property settlement.
Third, a spouse at the time of divorce has a large number of shares on paper in a company that has not gone public. The shares in the early stages have no great value because the company is just starting and is not profitable. However, the company could become profitable and could go public someday; in this situation, the other spouse should be sure to claim the marital share of this stock – that spouse may not become the next Google millionaire, but the possibility is worth taking the marital share.
Each spouse should consider the risks associated with any stock option and determine what makes sense financially in terms of whether to use the value to negotiate for other more defined assets, to negotiate for cash or debt relief, or to roll the dice on the big reward of a payout years in the future.
If you have questions about stock options and divorce, contact us – we can help.