copyright net worth strategies, inc. 2011 making timely & informed equity compensation decisions...

Copyright Net Worth Strategies, Inc. 2011

Making Timely & Informed

Equity CompensationDecisions

An Employee Workshop from:

Net Worth Strategies, Inc.


Workshop Objectives

Provide unique insights regarding one’s company stock and option holdings

Facilitate timely diversification decisions to maximize the value of your grants

Introduce a new platform for equity compensation recipient communication & decision support


Background

Net Worth Strategies, Inc.: The leading provider of equity compensation

education, communication & decision support solutions

Program Components: Workshop Presentation Equity Compensation Benefit Statement Access to www.StockOpter.com

http://www.stockopter.com/


Agenda

Myths and Truths about Equity Comp.

Overview of StockOpter®: Equity Compensation Benefit Statement

Equity Compensation Concepts & Taxation

StockOpter Analysis Output

Resources and Tools


Equity Compensation

Misconceptions &

Truths


Common Misconceptions Getting assistance or creating an equity

comp. strategy is unnecessary One should exercise / sell when:

Options expire or employment is terminated Money is needed Stock price target is met

Taxation can be avoided I’m now getting Restricted Stock Grants so

managing my Stock Options is unnecessary

Equity Comp. Truths Careful planning and professional assistance

facilitates better decisions & reduces costly mistakes

Exercise / sell decisions should be based on: Remaining time value / leverage not stock price alone Financial goals not just cash flow requirements Level of concentration in company stock and options

Taxes are unavoidable but they can be managed Outstanding Stock Option Grants still require timely

action


StockOpter® Equity Compensation

Benefit Statement


Equity Comp Benefit Stmt.* Grant Summary & Key Findings Stock Option Valuation

In-the-Money Value Table Time / Black Scholes Value Table

Restricted Share Value Table Forfeit Value Calculations Leverage Table Insight Ratios Table (Stock Options)

All Reported Dollar Amounts are Pre-Tax All Reported Dollar Amounts are Pre-Tax


Equity Compensation Concepts


What are Stock Options?

Definition: A grant of the right to purchase company

stock in the future at a fixed (grant) price

Grant Price: (aka – exercise, strike or option price)

It is the price at which an employee can exercise the stock option, once vested

Vesting Date: The date when a traunch of options can be

exercised


Stock Option Definitions

Bargain Element: (aka: Spread)

The difference between the option exercise price & the market price of the stock at exercise

Exercise: The process of purchasing the option shares at

the grant price

Selling: Selling the purchased shares stock of an

exercised option (the option itself is not sold)


Restricted Stock Definitions

Restricted Stock Award = RSA A Grant of employer stock at no cost or

substantial discount that is subject to restrictions

AKA: Restricted Stock Unit = RSU

Types of Restrictions Time Vesting (i.e. Future Date)

Performance Vesting (i.e. Revenue Target)


Stock Option Valuation

In-the-Money Value (ITMV): Fair Market Value (FMV) – Grant Price x Shares

Option Value (aka: Full or Black-Scholes Value [BSV]): Made up of two components:

In-the-Money Value + Time Value (TV)

Time Value is estimated using methodologies including the Black-Scholes formula

BSV = TV + ITMV


Time Value Illustration

Strike Price Option Price

Expiry Jan. 2010 Expiry Jan. 2011

50.00 10.20 11.50

60.00 3.00 5.30

60.54 Last Trade As of 9/9/09

65.00 1.05 3.10

70.00 0.25 1.75

In the Money

Under Water

General Mill (GIS) Market Traded Options as of Sept 9, 2009 General Mill (GIS) Market Traded Options as of Sept 9, 2009


Option Valuation Methods Practical Applications:

Valuing Market Traded Options Expensing Stock Options on Financial Statements Valuing Employee Stock Options for decision support

Black-Scholes is the most broadly used and practical model for valuing employee stock options for decision support because the assumptions used are less complicated than alternatives

The Binomial model is an alternative to Black-Scholes that financial experts believe can produce lower values for expensing purposes because it uses changes in volatility and option-forfeiture rates


Estimating Time Value

The Black Scholes formula calculates the Time Value of a stock option using the following factors:

1. Time until expiration

2. Volatility of the stock price

3. The In-the-money value / Leverage

4. Risk free rate of return (RFR)

5. Per share dividend


Time Until Expiration

Total Option Value

Years

60 2 4 108

Time Value Element

Spread

Time Value decreases as the expiration date approaches.Time Value decreases as the expiration date approaches.


Stock Price Volatility The annualized standard deviation of the stock's

changes in price Expressed as a percentage (i.e. std dev of 0.3 is

volatility of 30%) Statistical method to provide range of possible

stock prices over option life Types of Volatility:

Historical: the actual volatility that occurred to the underlying stock during some look back time period

Implied: the market's estimate of future volatility derived from the option's bid/ask mid price


GIS Volatility

12 Month Price Volatility of GIS Stock

A volatile stock has a higher upside potential over time. The greater the volatility, the higher the Time Value.A volatile stock has a higher upside potential over time. The greater the volatility, the higher the Time Value.

http://www.ivolatility.com/%20%20%20%20/options.j?ticker=GIS:NYSE&R=1&period=12&chart=0&vct=4


Volatility Selection Depends on application:

Valuing Employee Stock Options for decision support Expensing Stock Options on Financial Statements Analyzing Market Traded Options

Consequently, selection is “art” not science Compare a variety of sources to validate:

Company Annual Report (SEC Filings) Market Traded Options: www.ivolatility.com Peer Comparisons (use for private companies)


In-the-Money Value

As the ITM value increases, TV decreases because upside leverage is less. As the ITM value increases, TV decreases because upside leverage is less.


Stock Option Leverage

Stock Option ITMV11.00$ $10.00 $1.00

10% Increase 12.10$ $10.00 $2.10 110%

High Leverage/TV: stock price is close to the option price...

Stock Option ITMV100.00$ $10.00 $90.00

10% Increase 110.00$ $10.00 $100.00 11%

Low Leverage/TV: option has significant ITM value...

The higher the current stock price is relative to the strike price, the less time value or upside leverage remains in the option.The higher the current stock price is relative to the strike price, the less time value or upside leverage remains in the option.


Risk Free Rate of Return

An option provides the holder with the right to own stock at a certain price without having to purchase the stock…

Consequently, an option’s value is enhanced by the ability to use the capital that would otherwise be invested in the stock for some other investment…

The Risk Free Rate represents the return on this other investment which enhances the value of the stock option

The higher the risk-free rate of return, the higher the BSV and TV of the option. The higher the risk-free rate of return, the higher the BSV and TV of the option.


The Risk Free Rate Affect

For option valuation purposes:

The Risk Free Rate can be derived from the yield on US Treasury bills or from similar investments

This value can also be found in the company’s annual report for the purpose of option expensing

The higher the Risk Free Rate of Return, the higher the Time Value of the option. The higher the Risk Free Rate of Return, the higher the Time Value of the option.


Per Share Dividend

Decrease an option’s Time Value because the holder is forgoing the dividend until the time of exercise

A dividend can produce negative Time Value depending on the other BSV factors

The inclusion of a dividend is not relevant if you intend to exercise and sell immediately for diversification purposes

The Time Value of an option is lower when the dividend is factored in.The Time Value of an option is lower when the dividend is factored in.


Time Value Factor Summary

TV decreases as the expiration date approaches.

TV decreases as the in-the-money amount increases.

TV is higher for stocks with higher volatility.

TV is higher when the risk free rate of return is higher.


Equity Compensation Taxation


Taxation Unavoidable! Occurs when the client takes ownership by

exercising stock options or when RSAs vest Incentive Stock Options (ISOs):

ISO’s trigger Alternative Minimum Tax (AMT) AMT planning is critical to optimize & avoid problems

Non Qualified Stock Options (NQSOs), Stock Appreciation Rights (SARs), & RSAs: Taxed at ordinary income rates (compensation) Cashless Exercise: sale proceeds used to pay

exercise price and withheld for taxes


ISOs: Tax Consequences

$100

$0Strike price

FMV at exercise

FMV at sale

AMT adjustment

AMTC.G.


$100

$0Strike price

FMV at exercise

FMV at sale

CompensationIncome

NQSOs: Tax ConsequencesNQSOs: Tax Consequences

Capital Gains


$100

$0 Grant

Vest

FMV at sale

CompensationIncome

Regular C.G.

RSAs: Tax Consequences

Capital Gains


RSA 83(b) Election

Accelerates taxation from date of vest to date of grant Starts CG holding period Eliminates taxation at vesting

Must be made within 30 days of the grant (or early exercise)

Election made by filing document with IRS Election is irrevocable


$100

$0

Grant

Vest

FMV at sale

CompensationIncome

83bElection Original C.G.

Additional C.G.

RSAs: 83b Consequences


Taxation Summary

Unavoidable (gifting retains tax liability)! Employee Stock Options:

NQSOs & SARs – compensation income when “Exercised”

ISOs – AMT planning is crucial

Restricted Stock Awards: Compensation income when restrictions lapse

(vest)


StockOpter® Analysis Output


Betty Crocker Example Financial Goal: $1,500,000 Diversified Portfolio Value: $750,000 Company: GIS (General Mills, Inc.) Current Stock Price: $60.00 Stock Volatility: 25% Risk Free Rate: 4.4% (10K) Income Tax Rate: 40% Cap Gains: 22% (Fed+State)

Stock Options: 7 – NQSOs: 21,625 vested & 13,160 unvested

Shares: 1,500 shares held (cost basis: $75,000) 10,000 RSAs (cost basis: $0)


StockOpter Tables/Charts In-the-Money Values* After Tax Values (full analysis)

Black Scholes, Time and Forfeit Values* Restricted Shares / Units Values* Owned Share Values (full analysis)

Leverage* Financial Goals (full analysis)

Concentration (full analysis)

Key Ratios*

* Included in Equity Comp. Benefit Statement


Grant ID Grant Type

Expire Date

Exercise Price

Vested Options

Vested ITMV $

Unvested Options

Unvested ITMV $

Total Options

Total ITMV $

2000 NQSO 1/18/2011 $40.4700 10,000 195,300 0 0 10,000 195,300 2001 NQSO 1/17/2012 $49.6100 3,625 37,664 0 0 3,625 37,664 2004 NQSO 1/13/2015 $46.9700 4,000 52,120 0 0 4,000 52,120 2006 NQSO 7/26/2016 $51.2600 4,000 34,960 0 0 4,000 34,960 2007 NQSO 7/25/2017 $58.7900 0 0 4,000 4,840 4,000 4,840 2008 NQSO 7/23/2018 $63.4000 0 0 2,000 0 2,000 0 2009 NQSO 7/29/2019 $55.8400 0 0 2,000 8,320 2,000 8,320

Total 21,625 320,044 8,000 13,160 29,625 333,204

In-the-Money Valuation

ITM Value = Current Value ($60) – Exercise Price x Shares


Grant ID Grant Type

Expire Date

Exercise Price

Vested Options

Vested ITMV $

Potential Tax $

After Tax

Value $ 2000 NQSO 1/18/2011 $40.4700 10,000 195,300 78,120 117,180 2001 NQSO 1/17/2012 $49.6100 3,625 37,664 15,066 22,598 2004 NQSO 1/13/2015 $46.9700 4,000 52,120 20,848 31,272 2006 NQSO 7/26/2016 $51.2600 4,000 34,960 13,984 20,976 2007 NQSO 7/25/2017 $58.7900 0 0 0 0 2008 NQSO 7/23/2018 $63.4000 0 0 0 0 2009 NQSO 7/29/2019 $55.8400 0 0 0 0

Total 21,625 320,044 128,018 192,026

Grant ID Grant Type

Expire Date

Exercise Price

Vested Options

Vested ITMV $

Potential Tax $

After Tax

Value $ 2000 NQSO 1/18/2011 $40.4700 10,000 195,300 78,120 117,180 2001 NQSO 1/17/2012 $49.6100 3,625 37,664 15,066 22,598 2004 NQSO 1/13/2015 $46.9700 4,000 52,120 20,848 31,272 2006 NQSO 7/26/2016 $51.2600 4,000 34,960 13,984 20,976 2007 NQSO 7/25/2017 $58.7900 0 0 0 0 2008 NQSO 7/23/2018 $63.4000 0 0 0 0 2009 NQSO 7/29/2019 $55.8400 0 0 0 0

Total 21,625 320,044 128,018 192,026

After Tax Valuation

Cash Out Value = ITM Value – Potential Tax (calculated by applying a 40% income tax

rate)


Grant ID

Grant Type

Expire Date

Exercise Price

Vested TV $

Vested BSV $

Unvested TV $

Unvested BSV $

Total TV $

Total BSV $

2000 NQSO 1/18/2011 $40.4700 27,107 222,407 0 0 27,107 222,407 2001 NQSO 1/17/2012 $49.6100 26,837 64,501 0 0 26,837 64,501 2004 NQSO 1/13/2015 $46.9700 51,537 103,657 0 0 51,537 103,657 2006 NQSO 7/26/2016 $51.2600 70,870 105,830 0 0 70,870 105,830 2007 NQSO 7/25/2017 $58.7900 0 0 94,825 99,665 94,825 99,665 2008 NQSO 7/23/2018 $63.4000 0 0 49,796 49,796 49,796 49,796 2009 NQSO 7/29/2019 $55.8400 0 0 50,412 58,732 50,412 58,732

Total 176,351 496,395 195,033 208,193 371,385 704,589

Black Scholes Valuation

Compare to ITM Value of $333,204

Black Scholes Value = Time Value + ITM Value


Grant ID

Grant Type

Expire Date

Exercise Price

Vested TV $

Vested BSV $

Unvested TV $

Unvested BSV $

Total TV $

Total BSV $

2000 NQSO 1/18/2011 $40.4700 27,107 222,407 0 0 27,107 222,407 2001 NQSO 1/17/2012 $49.6100 26,837 64,501 0 0 26,837 64,501 2004 NQSO 1/13/2015 $46.9700 51,537 103,657 0 0 51,537 103,657 2006 NQSO 7/26/2016 $51.2600 70,870 105,830 0 0 70,870 105,830 2007 NQSO 7/25/2017 $58.7900 0 0 94,825 99,665 94,825 99,665 2008 NQSO 7/23/2018 $63.4000 0 0 49,796 49,796 49,796 49,796 2009 NQSO 7/29/2019 $55.8400 0 0 50,412 58,732 50,412 58,732

Total 176,351 496,395 195,033 208,193 371,385 704,589

Option Forfeit Valuation

Forfeit Value®

$384,544

Vs. ITM Value of

Unvested: $13,160

Forfeit Value = Time Value of

Vested + BSV of Unvested


Restricted Share Values

Shows estimate tax liabilities & net shares at

vesting

Gross RSA Value = Shares * FMV

Grant ID Grant Type Shares

Gross Value $

Potential Tax $

After Tax

Value $ RS1 RSA 500 30,000 12,000 18,000 RS2 RSA 500 30,000 12,000 18,000

Total 1,000 60,000 24,000 36,000

Year Shares Vesting

Tax Liability

at: 38.40

Tax Liability

at: 48.00

Tax Liability

at: 60.00

Tax Liability

at: 72.00

Tax Liability

at: 86.40

Shares Required

Net Shares

2011 500 7,680 9,600 12,000 14,400 17,280 200 300 2012 500 7,680 9,600 12,000 14,400 17,280 200 300


Forfeit Value® at $60.00

Vested and Unvested Stock Options (Pre-Tax): $384,544 Unvested Restricted Stock Awards (Pre-Tax): $60,000 The Total Pre-Tax Forfeit Value® of Your Equity Compensation: $444,544

Total Forfeit Value

Total Forfeit Value = Option Forfeit Value + RSA Value


Description Amount Number of Shares 1,500 Gross Value 90,000 Cost Basis 75,000 Taxable Gain 15,000 Potential Tax 3,300 After Tax Value 86,700

Owned Share Valuation

GIS Stock Price: $60

After Tax Value of Owned Shares = Share * Price – Basis * Cap Gains Rate (22%)


Potential Stock Price

Incremental Change

Option Value $

Option Value

Change

RSA & Owned

Shares $

RSA & Owned Change

Option, RSA &

Owned $

Option, RSA & Owned

$24.58 -20.00 % 0 0.00 % 61,450 -20.00 % 61,450 -19.99 % $30.72 -20.00 % 0 0.00 % 76,800 -20.00 % 76,800 -20.00 % $38.40 -20.00 % 0 -100.00 % 96,000 -20.00 % 96,000 -51.86 % $48.00 -20.00 % 79,420 -76.16 % 120,000 -20.00 % 199,420 -58.73 % $60.00 0.00 % 333,204 0.00 % 150,000 0.00 % 483,204 0.00 % $72.00 20.00 % 681,904 104.65 % 180,000 20.00 % 861,904 78.37 % $86.40 20.00 % 1,108,504 62.56 % 216,000 20.00 % 1,324,504 53.67 %

$103.68 20.00 % 1,620,424 46.18 % 259,200 20.00 % 1,879,624 41.91 % $124.42 20.00 % 2,234,846 37.92 % 311,050 20.00 % 2,545,896 35.45 % $149.30 20.00 % 2,971,916 32.98 % 373,250 20.00 % 3,345,166 31.39 %

Leverage

A 20% increase in stock price yields

a 104.65% increase in ITM

value

A 20% decrease in stock price yields

a 76.16% decrease in ITM value


Financial Goal Attainment

Financial Goal

Value of Diversified Portfolio (VDP)

Vested share goal status at

various prices


Concentration

39% of portfolio is in

company stock or options

Pre-Tax Values


Grant ID

Grant

Type Expire Date

Exercise Price

Vested ITMV $

Vested TV $

VaR Value

VaR Ratio

Vested BSV $

Insight Ratio

2000 NQSO 1/18/2011 $40.4700 195,300 27,107 68,092 39.81 % 222,407 12.19 % 2001 NQSO 1/17/2012 $49.6100 37,664 26,837 24,683 108.72 % 64,501 41.61 % 2004 NQSO 1/13/2015 $46.9700 52,120 51,537 27,237 189.22 % 103,657 49.72 % 2006 NQSO 7/26/2016 $51.2600 34,960 70,870 27,237 260.20 % 105,830 66.97 % 2007 NQSO 7/25/2017 $58.7900 0 0 0 1,000.00 % 0 100.00 % 2008 NQSO 7/23/2018 $63.4000 0 0 0 1,000.00 % 0 100.00 % 2009 NQSO 7/29/2019 $55.8400 0 0 0 1,000.00 % 0 100.00 %

Total 320,044 176,351 147,250 496,395

Key Ratios

This grant’s “Insight Ratio” means 87.81% of its full value is ITM Value


Insight Ratios

The Insight Ratio is TV divided by BSV Represents the remaining theoretical potential 10% means 90% of theoretical potential has

been achieved

Provides a framework for diversifying based on risk v. reward

Planning horizon and risk profile are key considerations


Insight Ratio Factors

Proximity to retirement?

Bullish on company growth prospects?

Concerned with negative leverage?

Close to achieving a financial goal?

Concentrated position?

Upcoming cash-flow requirements?


Key Ratio Considerations*

Risk ProfileInsight Ratio

(TV/BSV)

Short/Conservative 30%-50%

Medium/Moderate 11%-29%

Long/Aggressive <10%

* These are only guidelines for establishing individual decision

criteria


Decision SupportResources & Tools


Decision Support

Making timely & informed equity comp. decision is an ongoing process

Resources: Online: www.StockOpter.com

Personalized Reports What-if Dashboards & Concept Videos Nightly Monitoring of Decision Triggers

Financial Advisors (specializing in equity comp.)

LinkedIn Group: Equity Compensation Recipients – Decision Support

http://www.stockopter.com/


StockOpter.com

Access: URL: www.StockOpter.com/participants UserID: work email Password: temp (case sensitive)

Terms: 60 Days no-charge Annual Subscription: $95

http://www.stockopter.com/participants


Next Steps

Review your E/C Benefit Statement Visit: StockOpter.com

Update My Data & review Dashboards View Concept Videos Create your Personal Equity Profile report Review and modify Monitoring triggers

Review this information with your advisor


Questions?

[email protected]


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