Download Equity Compensation Seminar Slides

Making Timely & Informed
Equity Compensation
Diversification Decisions
An Employee Workshop from:
Net Worth Strategies, Inc.
Copyright Net Worth Strategies, Inc. 2016
Workshop Objectives

Provide you with unique insights
regarding your company stock and
option holdings

Enable you to make timely diversification
decisions to maximize the value of your
grants
Copyright Net Worth Strategies, Inc. 2016
Background


PRESENTER / FIRM NAME

INFO

INFO
Net Worth Strategies, Inc.:

Developer of the industry’s best equity
compensation diversification tools

Website: www.StockOpter.com
Copyright Net Worth Strategies, Inc. 2016
Agenda

Myths and Truths about Equity Comp.

StockOpter Personal Equity Compensation
Analysis

Equity Compensation Concepts & Taxation

StockOpter Analysis Output

Resources and Tools
Copyright Net Worth Strategies, Inc. 2016
Equity Compensation
Misconceptions
&
Truths
Copyright Net Worth Strategies, Inc. 2016
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
Copyright Net Worth Strategies, Inc. 2016
Equity Comp. Truths

Careful planning and professional assistance
facilitates informed 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
The
Personal Equity
Compensation Analysis
Copyright Net Worth Strategies, Inc. 2016
Equity Comp. Analysis

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Portfolio Summary & Key Findings
Stock Option Valuation
Restricted / Owned Share Valuation
Forfeit Value
Investment Risk / Reward
Financial Attainment Analysis
Concentrated Position Analysis
Value at Risk (VaR)
Insight Ratios Table (Stock Options)
Copyright Net Worth Strategies, Inc. 2016
Equity Compensation
Concepts
Copyright Net Worth Strategies, Inc. 2016
What are Stock Options?

Definition:


Grant Price: (aka – exercise, strike or option price)


A grant of the right to purchase company
stock in the future at a fixed (grant) 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
Copyright Net Worth Strategies, Inc. 2016
Stock Option Definitions

Bargain Element: (aka: Spread)
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
Exercise:


The difference between the option exercise
price & the market price of the stock at 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)
Copyright Net Worth Strategies, Inc. 2016
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)
Copyright Net Worth Strategies, Inc. 2016
Stock Option Valuation

In-the-Money Value (ITMV):
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
Fair Market Value (FMV) – Grant Price x Shares
Option Value (aka: Full or Black-Scholes Value [BSV]):

Made up of two components:
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In-the-Money Value + Time Value (TV)

Time Value is estimated using methodologies
including the Black-Scholes formula

BSV = TV + ITMV
Copyright Net Worth Strategies, Inc. 2016
Time Value Illustration
Strike Price
In the Money
$65.00
$70.50
Under Water
$75.00
Option Price
Expiry Dec 16, 2016
Expiry March 17, 2017
$7.01
$8.40
Last Trade
As of 8/8/16
$1.25
$2.50
NDAQ Market Traded Options as of August 8, 2016
Copyright Net Worth Strategies, Inc. 2016
Option Valuation Methods
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Practical Applications:
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Valuing Market Traded Options
Expensing Stock Options on Financial Statements
Valuing Employee Stock Options for diversification
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 BlackScholes that financial experts believe can produce
lower values for expensing purposes because it
uses changes in volatility and option-forfeiture
rates
Copyright Net Worth Strategies, Inc. 2016
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
Copyright Net Worth Strategies, Inc. 2016
Time Until Expiration
Time Value
Element
Total Option
Value
Spread
0
2
4
6
8
Years
Time Value decreases as the expiration date approaches.
Copyright Net Worth Strategies, Inc. 2016
10
Stock Price Volatility

The annualized standard deviation of the stock's
changes in price
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Expressed as a percentage (i.e. std dev of 0.3 is
volatility of 30%)
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Statistical method to provide range of possible
stock prices over option life
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Types of Volatility:
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Historical: the actual volatility that occurred to the
underlying stock during some look back time period
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Implied: the market's estimate of future volatility derived
from the option's bid/ask mid price
Copyright Net Worth Strategies, Inc. 2016
NDAQ Volatility
12 Month Price Volatility of NDAQ Stock as of 8/9/16
A volatile stock has a higher upside potential over time.
The greater the volatility, the higher the Time Value.
Copyright Net Worth Strategies, Inc. 2016
Volatility Selection
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Depends on application:
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Valuing Employee Stock Options for diversification
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Expensing Stock Options on Financial Statements
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Analyzing Market Traded Options
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Consequently, selection is an “art” not “science”
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Compare a variety of sources to validate:
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Company Annual Report (SEC Filings)
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Market Traded Options: www.ivolatility.com

Peer Comparisons (use for private companies)
Copyright Net Worth Strategies, Inc. 2016
In-the-Money Value
As the ITM value increases, TV decreases because upside leverage is less.
Copyright Net Worth Strategies, Inc. 2016
Stock Option Leverage
High Leverage/TV: stock price is close to the option price...
Stock
$
11.00
10% Increase $
12.10
Option
$10.00
$10.00
ITMV
$1.00
$2.10
110%
Low Leverage/TV: option has significant ITM value...
Stock
$ 100.00
10% Increase $ 110.00
Option
$10.00
$10.00
ITMV
$90.00
$100.00
11%
The higher the current stock price is relative to the strike price, the
less time value or upside leverage remains in the option.
Copyright Net Worth Strategies, Inc. 2016
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…
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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.
Copyright Net Worth Strategies, Inc. 2016
The Risk Free Rate Affect

For option valuation purposes:
The higher the Risk Free Rate of Return, the higher the Time Value of the option.

The Risk Free Rate can be derived from the
yield of intermediate term bodns or from
similar investments

This value can also be found in the
company’s annual report for the purpose of
option expensing
Copyright Net Worth Strategies, Inc. 2016
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.
Copyright Net Worth Strategies, Inc. 2016
Time Value Factor Summary
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TV decreases as the expiration date
approaches.
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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.
Copyright Net Worth Strategies, Inc. 2016
Equity Compensation
Taxation
Copyright Net Worth Strategies, Inc. 2016
Taxation

Unavoidable!

Occurs when the client takes ownership by
exercising stock options or when RSAs vest
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Incentive Stock Options (ISOs):
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
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
Copyright Net Worth Strategies, Inc. 2016
ISOs: Tax Consequences
$100
FMV at sale
FMV at exercise
AMT
C.G.
AMT adjustment
$0
Strike price
Copyright Net Worth Strategies, Inc. 2016
NQSOs: Tax Consequences
$100
FMV at sale
FMV at exercise
Capital Gains
Compensation
Income
$0
Strike price
Copyright Net Worth Strategies, Inc. 2016
RSAs: Tax Consequences
$100
FMV at sale
Vest
Regular
C.G.
Capital Gains
Compensation
Income
$0
Grant
Copyright Net Worth Strategies, Inc. 2016
RSA 83(b) Election

Accelerates taxation from date of vest to
date of grant
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Starts capital gains holding period
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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
Copyright Net Worth Strategies, Inc. 2016
RSAs: 83b Consequences
$100
FMV at sale
83b
Election
Vest
Original Cap. Gains
Additional Cap. Gains
Grant
$0
Compensation
Income
Copyright Net Worth Strategies, Inc. 2016
Taxation Summary

Unavoidable (gifting retains tax liability)!
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Employee Stock Options:
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NQSOs & SARs – compensation income
when “Exercised”
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ISOs – AMT planning is crucial
Restricted Stock Awards:

Compensation income when restrictions lapse
(vest)
Copyright Net Worth Strategies, Inc. 2016
®
StockOpter
Analysis
Output
Copyright Net Worth Strategies, Inc. 2016
Sally Sample Example
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Financial Goal: $3,000,000
Diversified Portfolio Value: $500,000
Company: NDAQ (Nasdaq, Inc.)
Current Stock Price: $70.00
Stock Volatility: 50% Risk Free Rate: 2%
Income Tax Rate: 40% Cap Gains: 20% (Fed+State)
Stock Options:
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4: 25,500 vested & 11,500 unvested
Shares:
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10,000 shares held (cost basis: $200,000)
6,500 RSAs (cost basis: $0)
Copyright Net Worth Strategies, Inc. 2016
StockOpter Tables/Charts
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Summary Values
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In-the-Money Values
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After Tax Values
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Black Scholes, Time and Forfeit Values
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Restricted Shares / Units Values
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Owned Share Values
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Leverage & Share Analysis
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Financial Goal Attainment
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Concentration
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Key Ratios
Copyright Net Worth Strategies, Inc. 2016
Portfolio Summary
Asset
Vested Stock Options
Unvested Stock Options
Restricted/Performance Shares
Company Owned Shares
Other Investments
Total
Pre Tax
After Tax
After Tax
Value
Pre Tax Percent
Value
Percent
1,097,550
36.03 %
658,530
31.24 %
293,550
9.64 %
176,130
8.36 %
455,000
14.94 %
273,000
12.95 %
700,000
22.98 %
600,000
28.47 %
500,000
16.41 %
400,000
18.98 %
3,046,100
100 %
2,107,660
100 %
Copyright Net Worth Strategies, Inc. 2016
In-the-Money Valuation
ITM Value = Current Value ($60) – Exercise Price x Shares
Copyright Net Worth Strategies, Inc. 2016
After Tax Valuation
Grant ID
SAR2009
NQ2011
NQ2013
ISO2015
Total
Grant
Expire
Exercise Vested
Type
Date
Price
Options
SAR 10/1/2019 $18.0600
5,000
NQSO 9/1/2021
$24.0000
10,000
NQSO 2/1/2023
$28.0000
7,500
ISO
5/1/2025
$49.0500
3,000
25,500
Vested
Potential After Tax
ITMV $
Tax $
Value $
259,700
103,880
155,820
460,000
184,000
276,000
315,000
126,000
189,000
62,850
25,140
37,710
1,097,550
439,020
658,530
Cash Out Value = ITM Value – Potential Tax
(calculated by applying a 40% income tax rate)
Copyright Net Worth Strategies, Inc. 2016
Black Scholes Valuation
Black Scholes Value = Time
Value + ITM Value
Compare to ITM
Value of $1,391,100
Copyright Net Worth Strategies, Inc. 2016
Option Forfeit Valuation
Forfeit Value =
Time Value of
Vested + BSV of
Unvested
Forfeit Value®
$744,636
Copyright Net Worth Strategies, Inc. 2016
Vs. ITM
Value of
Unvested:
$293,550
Restricted Share Values
Grant ID
PG1
RU2
Total
Grant
Type
PSG
RSU
Gross Value Potential
After Tax
Shares
$
Tax $
Value $
3,000
210,000
84,000
126,000
3,500
245,000
98,000
147,000
6,500
455,000
182,000
273,000
Gross RSA Value =
Shares * FMV
Year
2017
2019
Tax
Tax
Tax
Tax
Tax
Shares Liability at: Liability at: Liability at: Liability at: Liability at: Shares
Vesting
44.80
56.00
70.00
84.00
100.80
Required Net Shares
3,000
53,760
67,200
84,000
100,800
120,960
1,200
1,800
3,500
62,720
78,400
98,000
117,600
141,120
1,400
2,100
Shows estimated tax liabilities
& net shares at vesting
Copyright Net Worth Strategies, Inc. 2016
Total Forfeit Value
Total Forfeit Value =
Option Forfeit Value + RSA Value
Copyright Net Worth Strategies, Inc. 2016
Owned Share Valuation
NDAQ Stock Price: $70
Description
Number of Shares
Gross Value
Cost Basis
Taxable Gain
Potential Tax
After Tax Value
Amount
10,000
700,000
200,000
500,000
100,000
600,000
After Tax Value of Owned Shares =
Share * Price – Basis * Cap Gains Rate (20%)
Copyright Net Worth Strategies, Inc. 2016
Leverage (All Grants)
Potential
Stock
Increment Option Value
Price
Change
$
$28.67 -20.00 %
106,450
$35.84 -20.00 %
285,700
$44.80 -20.00 %
509,700
$56.00 -20.00 %
873,100
$70.00
0.00 %
1,391,100
$84.00
20.00 %
1,909,100
$100.80
20.00 %
2,530,700
$120.96
20.00 %
3,276,620
$145.15
20.00 %
4,171,650
$174.18
20.00 %
5,245,760
Option
Value
Change
-62.74 %
-43.95 %
-41.62 %
-37.24 %
0.00 %
37.24 %
32.56 %
29.47 %
27.32 %
25.75 %
Leverage: a 20%
increase or decrease in
price yields a greater
change in Option value
RSA &
Owned
Shares $
473,055
591,360
739,200
924,000
1,155,000
1,386,000
1,663,200
1,995,840
2,394,975
2,873,970
RSA &
Owned Option, RSA
Change & Owned $
-20.00 %
579,505
-20.00 %
877,060
-20.00 %
1,248,900
-20.00 %
1,797,100
0.00 %
2,546,100
20.00 %
3,295,100
20.00 %
4,193,900
20.00 %
5,272,460
20.00 %
6,566,625
20.00 %
8,119,730
Option,
RSA &
Owned
-33.93 %
-29.77 %
-30.50 %
-29.42 %
0.00 %
29.42 %
27.28 %
25.72 %
24.55 %
23.65 %
NO Leverage: a 20%
price change yields
the same change in
Share value
Copyright Net Worth Strategies, Inc. 2016
Leverage (Individual Options)
Grant
Grant ID Type
SAR2009
SAR
NQ2011
NQSO
NQ2013
NQSO
ISO2015
ISO
Current
Stock
Current
Price
Value
$70.00 259,700
$70.00 460,000
$70.00 420,000
$70.00 251,400
Price
+20%
$84.00
$84.00
$84.00
$84.00
Value
+%
Price Value +20%
Change
20%
20%
329,700 26.95 % $56.00 189,700
600,000 30.43 % $56.00 320,000
560,000 33.33 % $56.00 280,000
419,400 66.83 % $56.00
83,400
The % change for individual options will
vary based on the differences in the
exercise prices (options with lower
exercise prices will have less leverage)
Copyright Net Worth Strategies, Inc. 2016
-%
Change
-26.95 %
-30.43 %
-33.33 %
-66.83 %
Share Valuation Analysis
Owned
Owned
Potential Increment RSA Gross RSA After Share Gross Share After Total Gross Total After
Stock Price Change
Value $
Tax Value $
Value $
Tax Value $
Value $
Tax Value $
$28.67
-20.00 %
186,355
111,813
286,700
269,360
473,055
381,173
$35.84
-20.00 %
232,960
139,776
358,400
326,720
591,360
466,496
$44.80
-20.00 %
291,200
174,720
448,000
398,400
739,200
573,120
$56.00
-20.00 %
364,000
218,400
560,000
488,000
924,000
706,400
$70.00
0.00 %
455,000
273,000
700,000
600,000
1,155,000
873,000
$84.00
20.00 %
546,000
327,600
840,000
712,000
1,386,000
1,039,600
$100.80
20.00 %
655,200
393,120
1,008,000
846,400
1,663,200
1,239,520
$120.96
20.00 %
786,240
471,744
1,209,600
1,007,680
1,995,840
1,479,424
$145.15
20.00 %
943,475
566,085
1,451,500
1,201,200
2,394,975
1,767,285
$174.18
20.00 %
1,132,170
679,302
1,741,800
1,433,440
2,873,970
2,112,742
Although Restricted and Owned shares do
not have leverage, incremental changes in
stock price can have a profound effect on
their value. This table quantifies the risk and
potential inherent in your company shares.
Copyright Net Worth Strategies, Inc. 2016
Financial Goal Attainment
Financial Goal
Vested share
goal status at
various prices
Value of Diversified
Portfolio (VDP)
Copyright Net Worth Strategies, Inc. 2016
Concentration
Pre-Tax
Values
84% of portfolio
is in company
stock or options
Copyright Net Worth Strategies, Inc. 2016
Key Ratios
This grant’s “Insight Ratio” means
96.71% of its full value is ITM Value.
Low ratios indicate small upside
potential and lots at risk.
Grant
Grant ID Type
SAR2009
SAR
NQ2011
NQSO
NQ2013
NQSO
ISO2015
ISO
Total
Expire
Date
10/1/2019
9/1/2021
2/1/2023
5/1/2025
Exercise Vested
Vested
Price
ITMV $
TV $
$18.0600 259,700
8,828
$24.0000 460,000
53,660
$28.0000 315,000
66,260
$49.0500
62,850
75,063
1,097,550 203,811
VaR
Vested
Value VaR Ratio BSV $
76,343 11.56 % 268,528
152,685 35.14 % 513,660
114,514 57.86 % 381,260
45,806 163.87 % 137,913
389,348
1,301,361
Copyright Net Worth Strategies, Inc. 2016
Insight
Ratio
3.29 %
10.45 %
17.38 %
54.43 %
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
Copyright Net Worth Strategies, Inc. 2016
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?
Copyright Net Worth Strategies, Inc. 2016
Key Ratio Considerations*
Risk Profile
Insight Ratio
(TV/BSV)
Short/Conservative
30%-50%
Medium/Moderate
11%-29%
Long/Aggressive
<10%
* These are only guidelines for
establishing individual decision criteria
Copyright Net Worth Strategies, Inc. 2016
Resources & Tools
Copyright Net Worth Strategies, Inc. 2016
Equity Comp. Assistance

Making timely & informed equity comp.
decision is an ongoing process

Resources:

Online: www.StockOpter.com

Application: Reports, Dashboards and Monitoring

StockOpter University: Free Articles, Videos and
White-Papers on Equity Comp. Diversification

Financial Advisors (specializing in equity comp.)

LinkedIn Group:
Equity Compensation Recipients – Decision Support
Copyright Net Worth Strategies, Inc. 2016
Next Steps

To get an analysis of your equity
compensation holdings:
1.
Sign up at the end of the seminar
2.
Provide your grant summary statement with
vesting schedule
3.
4.
Include number of “long/owned” shares and
total cost basis
Estimate the value of your other investments
Copyright Net Worth Strategies, Inc. 2016
Questions?
Copyright Net Worth Strategies, Inc. 2016
Thank You for Attending
Copyright Net Worth Strategies, Inc. 2016