How to Get the MostHow to Get the MostFrom YourFrom Your

Equity CompensationEquity Compensation

Presented by:Presented by:

John P. Barringer, John P. Barringer, CFP®CFP®

Vice President, Investment Management Consultant & Corporate Client Group DirectorVice President, Investment Management Consultant & Corporate Client Group Director

Morgan Stanley Smith BarneyMorgan Stanley Smith Barney

Seminar ObjectiveSeminar Objective

We will provide attendees with a We will provide attendees with a decision-making framework for decision-making framework for

their stock options and other forms their stock options and other forms of equity compensation that can of equity compensation that can

optimize the value of these optimize the value of these holdings, employing timely holdings, employing timely

decisions and efficient tax and decisions and efficient tax and cash-flow management.cash-flow management.

BackgroundBackground

• Our Corporate Client group specializes in Our Corporate Client group specializes in assisting employees to maximize the value assisting employees to maximize the value of their equity compensation.of their equity compensation.

• Other services and benefitsOther services and benefits John P. Barringer, John P. Barringer, CFP®CFP® : :

• BackgroundBackground• Equity Compensation Planning ExperienceEquity Compensation Planning Experience

Our Client-Centered ApproachOur Client-Centered ApproachOur client-centered approach includes a disciplined five-step process that enables us to help you craft a solution that can help you meet your individual financial needs and goals.

Throughout this process, we will provide you with information and alternatives to help you determine whether a brokerage and/or advisory relationship with Morgan Stanley is most appropriate for you.

Help you develop a thorough understandingof your financial goals and objectives

Help you review and analyze your current

financial situation

Help you identify and tailor solutions that can help you meet

your individual financial needs and goals

Help you implement your customized strategy, including

personalized services and benefits

Maintain an ongoing commitment to you,

monitor progress, and periodically review

strategies

Before We Begin…Before We Begin…

Has anyone here made any mistakes with their Has anyone here made any mistakes with their stock options or other forms of equity stock options or other forms of equity compensation? What kind?compensation? What kind?

What is your approach for determining when to What is your approach for determining when to exercise and sell your options? How effective is exercise and sell your options? How effective is it?it?

Who do you talk to for assistance and how often Who do you talk to for assistance and how often do you review your E/C portfolio?do you review your E/C portfolio?

Common MisconceptionsCommon Misconceptions Maximizing equity compensation value Maximizing equity compensation value

is just luck so getting assistance or is just luck so getting assistance or creating a strategy is unnecessarycreating a strategy is unnecessary

One should exercise / sell when:One should exercise / sell when:• Options expire or employment is Options expire or employment is

terminatedterminated• Money is neededMoney is needed• Stock price target is metStock price target is met

Taxation can be avoidedTaxation can be avoided Restricted shares are preferable to Restricted shares are preferable to

optionsoptions

Truths About Equity CompTruths About Equity Comp Careful planning and professional assistance Careful planning and professional assistance

facilitates better decisions & reduces costly mistakesfacilitates better decisions & reduces costly mistakes Exercise / sell decisions should be based on:Exercise / sell decisions should be based on:

• Remaining time value / leverage not stock price Remaining time value / leverage not stock price alonealone

• Financial goals not just cash flow requirementsFinancial goals not just cash flow requirements• Level of concentration in company stock and Level of concentration in company stock and

optionsoptions Taxes are unavoidable but they can be managedTaxes are unavoidable but they can be managed The leverage inherent in options builds wealth more The leverage inherent in options builds wealth more

effectively than restricted shares in growing effectively than restricted shares in growing companiescompanies

A Process for A Process for ““Optimizing” ValueOptimizing” Value

Step 1Step 1: Portfolio Analysis: Portfolio Analysis

• Determines Determines “when”“when” to exercise / sell by to exercise / sell by quantifying value, leverage and risk quantifying value, leverage and risk

Step 2Step 2: Manage taxes and cash-flow: Manage taxes and cash-flow

• Model exercise / sell strategies to Model exercise / sell strategies to optimize tax and cash flow efficiencyoptimize tax and cash flow efficiency

Portfolio AnalysisPortfolio Analysis Establishes a decision framework Establishes a decision framework

that facilitates timely and prudent that facilitates timely and prudent actionaction

Required input:Required input:• Grant data and vesting scheduleGrant data and vesting schedule

• Financial assumptionsFinancial assumptions

Should be discussed with a financial Should be discussed with a financial advisor to interpret the dataadvisor to interpret the data

Needs to be updated periodically Needs to be updated periodically

Sample Option HolderSample Option Holder Financial Goal: Financial Goal: $2,000,000$2,000,000 Diversified Portfolio Value: Diversified Portfolio Value: $500,000$500,000 Company: Company: XYZXYZ Current Stock Price: Current Stock Price: $20$20 Estimated Stock Volatility: Estimated Stock Volatility: 40%40% (annual report) (annual report) Income Tax Rate: Income Tax Rate: 35% 35% (combined state & fed)(combined state & fed) Stock Options:Stock Options:

• 2 - ISOs: 2 - ISOs: 65,000 vested 65,000 vested • 3 - NQSOs: 3 - NQSOs: 70,000 vested & 60,000 unvested70,000 vested & 60,000 unvested

Shares:Shares:• 20,000 shares held20,000 shares held (cost basis: $300K) (cost basis: $300K)• 1,500 restricted shares1,500 restricted shares (cost basis: $0) (cost basis: $0)

Portfolio Analysis SegmentsPortfolio Analysis Segments

Valuation:Valuation:• In-the-money ValueIn-the-money Value• Cash-out ValueCash-out Value• Black Scholes, Time and Forfeit Black Scholes, Time and Forfeit

ValuesValues LeverageLeverage Financial goalsFinancial goals ConcentrationConcentration Decision MetricsDecision Metrics

Current FMV $20.00 Vested Unvested Total

Grant ID Option Type

Expiration Date

Strike Price

# of Options ITM Value

# of Options

ITM Value

# of Options ITM

1 ISO 97 ISO 01/01/07 $13.00 40,000 280,000 0 0 40,000 280,000

2 ISO 98 ISO 01/01/08 $15.00 25,000 125,000 0 0 25,000 125,000

3 NQ 00 NQSO 01/01/10 $41.80 40,000 0 0 0 40,000 0

4 NQ 02 NQSO 01/01/12 $19.65 30,000 10,500 20,000 7,000 50,000 17,500

5 NQ 04 NQSO 01/01/14 $20.11 0 0 40,000 0 40,000 0

Grand Total 135,000 415,500 60,000 7,000 195,000 422,500

In-the-Money ValuationIn-the-Money Valuation

ITM Value = Current FMV (Fair Market ITM Value = Current FMV (Fair Market Value) – Grant Price x # of sharesValue) – Grant Price x # of shares

Cash Out ValuationCash Out ValuationCurrent

FMV $20.00 Vested

Grant ID Option Type

Expiration Date

Strike Price

# of Options ITM Value

Potential Tax

Cash out Value, Vested

1 ISO 97 ISO 01/01/07 $13.00 40,000 280,000 98,000 182,000

2 ISO 98 ISO 01/01/08 $15.00 25,000 125,000 43,750 81,250

3 NQ 00 NQSO 01/01/10 $41.80 40,000 0 0 0

4 NQ 02 NQSO 01/01/12 $19.65 30,000 10,500 3,675 6,825

5 NQ 04 NQSO 01/01/14 $20.11 0 0 0 0

Grand Total 135,000 415,500 145,425 270,075

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

rates)rates)

Current FMV $20.00 Vested Unvested Total

Grant ID Option Type

Expiration Date

Strike Price

Time value BSV

Time Value BSV Time value BSV

1 ISO 97 ISO 01/01/07 $13.00 62,007 342,007 0 0 62,007 342,007

2 ISO 98 ISO 01/01/08 $15.00 81,025 206,025 0 0 81,025 206,025

3 NQ 00 NQSO 01/01/10 $41.80 136,123 136,123 0 0 136,123 136,123

4 NQ 02 NQSO 01/01/12 $19.65 274,015 284,515 182,676 189,676 456,691 474,191

5 NQ 04 NQSO 01/01/14 $20.11 0 0 423,389 423,389 423,389 423,389

Grand Total 553,169 968,669 606,065 613,065 1,159,234 1,581,734

Black Scholes ValuationBlack Scholes Valuation

Compare to ITM Compare to ITM Value of $422,500Value of $422,500Compare to ITM Compare to ITM

Value of $422,500Value of $422,500Black Scholes Value = Black Scholes Value =

Time Value + ITM ValueTime Value + ITM ValueBlack Scholes Value = Black Scholes Value =

Time Value + ITM ValueTime Value + ITM Value

Forfeit ValuationForfeit Valuation

Forfeit ValueForfeit Value™™

$1,166,234$1,166,234

Vs. ITM Vs. ITM Value of Value of

Unvested Unvested $7,000$7,000

Vs. ITM Vs. ITM Value of Value of

Unvested Unvested $7,000$7,000

Current FMV $20.00 Vested Unvested Total

Grant ID Option Type

Expiration Date

Strike Price

Time value BSV

Time Value BSV Time value BSV

1 ISO 97 ISO 01/01/07 $13.00 62,007 342,007 0 0 62,007 342,007

2 ISO 98 ISO 01/01/08 $15.00 81,025 206,025 0 0 81,025 206,025

3 NQ 00 NQSO 01/01/10 $41.80 136,123 136,123 0 0 136,123 136,123

4 NQ 02 NQSO 01/01/12 $19.65 274,015 284,515 182,676 189,676 456,691 474,191

5 NQ 04 NQSO 01/01/14 $20.11 0 0 423,389 423,389 423,389 423,389

Grand Total 553,169 968,669 606,065 613,065 1,159,234 1,581,734

Forfeit Value = Forfeit Value = Time Value of Time Value of

Vested + BSV of Vested + BSV of UnvestedUnvested

Forfeit Value = Forfeit Value = Time Value of Time Value of

Vested + BSV of Vested + BSV of UnvestedUnvested

Based on Current Portfolio of Vested and Unvested Options Potential

Future Stock Price

Incremental Change ITM Value

Incremental Change

Black- Scholes

Value Incremental

Change Cash-out

value Incremental

Change

$8.19 -20.0% $0 0.0% $243,837 -40.1% $0 0.0%

$10.24 -20.0% $0 0.0% $406,744 -38.4% $0 0.0%

$12.80 -20.0% $0 -100.0% $660,234 -36.4% $0 -100.0%

$16.00 -20.0% $145,000 -65.7% $1,038,773 -34.3% $94,250 -65.7%

$20.00 $422,500 $1,581,734 $274,625

$24.00 20.0% $1,038,100 145.7% $2,178,512 37.7% $674,765 145.7%

$28.80 20.0% $1,782,100 71.7% $2,943,097 35.1% $1,158,365 71.7%

$34.56 20.0% $2,674,900 50.1% $3,908,291 32.8% $1,738,685 50.1%

$41.47 20.0% $3,745,950 40.0% $5,112,473 30.8% $2,434,868 40.0%

$49.77 20.0% $5,351,250 42.9% $6,603,355 29.2% $3,478,313 42.9%

Leverage AnalysisLeverage Analysis

A 20% A 20% increaseincrease in in stock price yields stock price yields

a 145.7% a 145.7% increaseincrease in ITM in ITM

valuevalue

A 20% A 20% increaseincrease in in stock price yields stock price yields

a 145.7% a 145.7% increaseincrease in ITM in ITM

valuevalue

A 20% A 20% decreasedecrease in stock price in stock price

yields a 65.7% yields a 65.7% decreasedecrease in ITM in ITM

valuevalue

Goal Based AnalysisGoal Based Analysis

Financial GoalFinancial GoalFinancial GoalFinancial Goal

Value of Diversif ied Value of Diversif ied PortfolioPortfolio

Value of Diversif ied Value of Diversif ied PortfolioPortfolio

Goal status Goal status at various at various

stock pricesstock prices

Goal status Goal status at various at various

stock pricesstock prices

Concentration AnalysisConcentration Analysis

58% of portfolio is 58% of portfolio is in company stock in company stock

or optionsor options

58% of portfolio is 58% of portfolio is in company stock in company stock

or optionsor options

Decision MetricsDecision Metrics Stock PriceStock Price Expiration DatesExpiration Dates Future Vesting DatesFuture Vesting Dates Goal AchievementGoal Achievement Key Ratios: Key Ratios: Insight & VaRInsight & VaR

Grant ID Option Type

Expiration Date

Strike Price

ITM Value Time value VaR VaR Ratio BSV

Insight Ratio™

1 ISO 97 ISO 01/01/07 $13.00 280,000 62,007 141,865 43.71% 342,007 18.13%

2 ISO 98 ISO 01/01/08 $15.00 125,000 81,025 88,665 91.38% 206,025 39.33%

3 NQ 00 NQSO 01/01/10 $41.80 0 136,123 0 1000.00% 136,123 100.00%

4 NQ 02 NQSO 01/01/12 $19.65 10,500 274,015 10,500 1000.00% 284,515 96.31%

5 NQ 04 NQSO 01/01/14 $20.11 0 0 0 0.00% 0 0.00%

Grand Total 415,500 553,169 241,030 968,669

82% of this grant’s 82% of this grant’s theoretic potential theoretic potential has been achievedhas been achieved

82% of this grant’s 82% of this grant’s theoretic potential theoretic potential has been achievedhas been achieved

Key Ratios: Key Ratios: Client IssuesClient Issues Terminating employment (Retirement)?Terminating employment (Retirement)?

Bullish on company growth prospects?Bullish on company growth prospects?

Concerned with negative leverage?Concerned with negative leverage?

Close to achieving your financial goal?Close to achieving your financial goal?

Concentrated position?Concentrated position?

Upcoming cash-flow requirements?Upcoming cash-flow requirements?

Taking ActionTaking Action

Managing taxes and cash flowManaging taxes and cash flow• Models the after-tax cash flow effects of Models the after-tax cash flow effects of

different exercise and sell / hold different exercise and sell / hold strategiesstrategies

• Requires input of specific tax Requires input of specific tax assumptionsassumptions

• Identifies tax optimization opportunities Identifies tax optimization opportunities • Compares and contrasts strategies using Compares and contrasts strategies using

different stock price growth assumptionsdifferent stock price growth assumptions

Modeling StrategiesModeling Strategies

Diversification:Diversification:• Comparing diversification rates & stock prices Comparing diversification rates & stock prices

to an alternative investmentto an alternative investment Cash Flow:Cash Flow:

• Illustrating the effects of exercising & sellingIllustrating the effects of exercising & selling• Determining exercise and tax costs Determining exercise and tax costs

Taxation:Taxation:• Tax effects of exercising (AMT & Ordinary)Tax effects of exercising (AMT & Ordinary)• Holding ISOs to get capital gains ratesHolding ISOs to get capital gains rates

Illustrating StrategiesIllustrating Strategies

Charts and tables Charts and tables used to compare used to compare

various strategiesvarious strategies

Charts and tables Charts and tables used to compare used to compare

various strategiesvarious strategies

Optimizing AlternativesOptimizing Alternatives

Tax optimization:Tax optimization:

• ISO disqualifying disposition analysis ISO disqualifying disposition analysis (determining if it is advantageous to sell the (determining if it is advantageous to sell the underlying stock prior to the 1 year holding underlying stock prior to the 1 year holding period)period)

• Exercising ISOs up to AMT limitExercising ISOs up to AMT limit

Cash flow optimization:Cash flow optimization:

• Achieving an after-tax cash flow amountAchieving an after-tax cash flow amount

• Achieving an after-tax diversification Achieving an after-tax diversification percentagepercentage

Tax Comparison AnalysisTax Comparison Analysis

A report comparing A report comparing the tax effects of the tax effects of

different strategiesdifferent strategies

A report comparing A report comparing the tax effects of the tax effects of

different strategiesdifferent strategies

SummarySummary Your equity compensation plays a key role in Your equity compensation plays a key role in

achieving your financial goals and building wealthachieving your financial goals and building wealth Maximizing the value of your E/C portfolio requires Maximizing the value of your E/C portfolio requires

careful planning and professional assistance careful planning and professional assistance Exercise / sell decisions should be based on:Exercise / sell decisions should be based on:

• Remaining time value / leverage not stock price Remaining time value / leverage not stock price alonealone

• Financial goals not just cash flow requirementsFinancial goals not just cash flow requirements• Level of concentration in company stock and Level of concentration in company stock and

optionsoptions Taxes are unavoidable but they can be managedTaxes are unavoidable but they can be managed

Life Cycle Solutions for IndividualsLife Cycle Solutions for Individuals Executive Financial ServicesExecutive Financial Services

Sales of restricted or control stock can be time consuming and complex. Our Restricted Stock Specialists can offer you their experience and knowledge to assist you in selling, margining or hedging your restricted or control securities.

• Liquidation of your restricted or concentrated stock position can occur through:

− Open Markets Sales

− Block Trades

− Private Placements

• We can assist you with possible risk management alternatives, which include:

− Collateral loans (margin) to create liquidity

− Exchange funds to achieve portfolio diversification and reduce concentrated positions

− Collars, call writing and protective puts to protect against market volatility

Whether you wish to turn your options into cash, own the stock for collateral, hold it for future use or spread the option exercise over a number of years for tax purposes, we can assist you in exercising your options in a timely and cost-effective manner.

Stock Option Strategies

Preset Diversification Programs (PDPs), also known as Rule 10b5-1 Trading Plans, allow executives and key insiders to buy or sell stock based on guidelines set forth in a predefined contract.

• A PDP can help:

− Provide an affirmative defense against claims of insider trading

− Dispose of stock on a predictable and consistent basis, mitigating downward price pressure

− Allow access to public markets without regard to corporate blackout periods (if allowed by the issuer’s insider trading policy)

− Through appropriate public disclosure, minimize negative market perception resulting from stock sales by executives or key insiders

Preset DiversificationPrograms (PDPs)Restricted Securities

Morgan Stanley’s dedicated Executive Financial Services team can assist you with various options and solutions pertaining to your restricted securities or concentrated stock position.

Next StepsNext Steps Sign up for a “Portfolio Analysis Sign up for a “Portfolio Analysis

Review” to establish your decision Review” to establish your decision frameworkframework

Provide us with:Provide us with:• A current grant summary statementA current grant summary statement• Financial assumptions (i.e. diversified Financial assumptions (i.e. diversified

portfolio value)portfolio value) Arrange for quarterly updates to Arrange for quarterly updates to

facilitate timely decisionsfacilitate timely decisions Model strategies as necessaryModel strategies as necessary

Thank You for AttendingThank You for Attending

Presented by:Presented by:

John P. Barringer, John P. Barringer, CFP®CFP®

Vice President, Investment Management ConsultantVice President, Investment Management Consultant & Corporate Client Group Director& Corporate Client Group Director

Morgan Stanley Smith BarneyMorgan Stanley Smith Barney