Basically it boils down to your prediction if the stock is going to be worth more than your strike price when it becomes liquid, and if you can tolerate the loss if you predict so and are wrong. Some scenarios this is a very good bet: you were early, your strike price is low, the company has had several valuations well above the strike price, the financials are healthy, and you can absorb the loss if you are wrong. The magnitude of the upside seems like it shouldn’t be a factor, if these are true, if you think the risk adjusted return can beat the market. In most cases where it is sane to exercise your options you’re expecting a multiple return, not a few points, so it basically should be irrelevant how much upside there is in absolute terms, once you’ve determined a full loss is tolerable.
In an absolute best case scenario where your strike price is 0 and the stock price is 100 (so the effective gain is infinite%) you're going to have income under the AMT regime of 100, and the effective tax rate under the AMT is around 30%. So you still have to pony up around 1/3rd of the current stock price in capital. This severely constrains the real multiple return that you can achieve when exercising into a non-liquid stock and exposes you to enormous downside risk if those returns do not materialize.
Definitely a factor to consider, but not dispositive.
This is the real problem here. While this used to be standard, many startups have started offering employees the maximum ten years allowed by the IRS. This is something to consider when joining a company: if they're not willing to give you the full ten years, why not? More: https://triplebyte.com/blog/extending-stock-option-exercise-... https://zachholman.com/posts/fuck-your-90-day-exercise-windo...
When I left, I bought my stock options.
I got a friendly letter in the mail a few years later telling me that the company had been restructured, and that my shares are now worthless.
If I'm getting shares as a part of equity, then I'll consider that as part of my comp package...however, if they're stock options, I generally completely disregard them: I haven't yet met a startup to change my mind.
When accepting venture funding, the VC capital will come in as preffered equity which is similar in some ways to permanent debt with no interest payments.
Old company is renamed something like "legacyabc"
A new company is formed with the old company's name. All personnel and IP is moved to the new company", all debt is left in the old company. Original share holders get a big payout.
The old company is now worthless. Shares are now worth less than the original strike price. Original company is likely dissolved.
Bad luck.
Generally you'll have to sign a new contract in the new company to keep working.
If you're really unlucky, your L1 (or w/e) visa is tied to the old company, you now have to leave the country, and can't easily transfer to this new company.
It's a bit weird that you would take wildly different views on the value of one vs the other.
I was an early employee at Twilio (#25) and much later at Okta. Following his advice saved me thousands when I early exercised in both cases. My only complaint is that I didn't find and apply his advice sooner.
The author is right. Most of the time it doesn't make sense to exercise. If you join early, the strike price will be lower but the risk will be higher aka the odds are lower. If you join later, the strike price will be higher but the risk should be lower aka the odds are better.
Regardless, having the liquidity at the right time can be hard, especially if you're caught in a layoff and don't have savings.
If they are valuing the common stock based on the last funding round which sold preferred shares, you are likely significantly overpaying both for your exercise price and in AMT tax, and that makes the investment significantly riskier.
If common share FMV is discounted appropriately, IMO a 409a valuation will reflect the extreme risk of common shares dilution in an unprofitable venture with large investor preferences, and you should have a very low exercise price with little to no AMT unless the company is already well into planning an IPO.
At past companies I saw common stock valuation that matched the funding round valuation, and you should never be paying that price for common shares. 1/10th that price is a good rule of thumb.
The second most important factor is that you can’t ever sell shares in a company that doesn’t have a market for its shares. That vast majority of companies do not have, and never will have, marketable securities.
The third factor for me would be if the shares are eligible for QSBS Section 1202 treatment (tax free up to $10 million), which ISO options are not, but NSOs can be but the 5 year holding period starts at the exercise date.
You have to pay AMT on the difference between your strike price and the current 409a price of common. It doesn't have much to do with where preferred is valued, other than the fact that a high preferred value, means that the updated 409a common might be higher.
So let us say, your strike price is $0.50 and you are fully vested after 4 years. The company recently does a round where preferred is at $3.00 per share and the new 409a is $1.25/share. When you leave this is what will happen - You need to pay the company $0.50 * number of options you have - You have to pay AMT on (1.25-0.5) * number of shares
With last year's tax law, one good thing is that AMT rules changed, so AMT might not apply. You should, of course, talk to your accountant/tax professional for the proper advice :-)
E.g. a company raising $5m Series D at a $30 million valuation, and which already has $10m in preferences. First you have to adjust the valuation because that $5m will be the first dollar out and might even be participating preferred - so they are getting 1/6th of the company for $5m but they are also getting basically a $5m note payable.
If you asked them what they would pay without the preference maybe it’s closer to $15m. Then you also have to adjust for the other outstanding preferences. So the common shares (which are likely to be even further diluted before they become marketable) in that case are presently nearly worthless.
Most people do not adequately consider the impact of preferred share preferences, future dilution, taxes, and marketability. These horseman turn a decision which might seem like at first glance to be, “Why give up the chance to participate in a future equity event?” into something more closely resembling a suckers bet.
Another factor is transfer restrictions. Most companies let their shareholders sell stock in the private markets. Some, however, are curmudgeons. The latter knock shareholders twice: once, by taking away a liquidity option, and again, by producing a selling rush at potential future liquidity events.
1) "Don’t forget though, you’ll have to pay taxes, because the value of your shares is likely greater than the price you paid to buy them."
This is not true if, like most stock options, yours are ISOs and you don't hit AMT.
2) "I didn’t have enough money"
There are now places that'll loan you money secured against the value of the shares themselves. If the alternative is not exercising the shares at all, this is a pure win (these services eat into your profits, but some is better than 0)
3) "I didn’t have enough time"
It's increasingly common for startups to have much more generous time spans for exercise. The 90 day window is required by law for ISOs, but many companies now autoconvert at the 90 day mark to NQSOs with much longer time spans, up to 10 years in some cases (Stripe, Pinterest, and Flexport are examples). This is something you should ask about before joining a company.
4) "I didn’t think the company would survive"/"I have a low risk tolerance"
These are the only ones that really matter. Like any investment, you gotta weigh the ROI and risk against your preferences.
I think for most folks in tech not hitting AMT with any reasonably sized option grant worth buying will be extremely rare:
1. Options vest, usually over a 4 year span, so if one, two, three years go by at your startup and there isn't a large difference between your strike price and the current valuation, well then that's a huge signal you don't want to buy in any case. 2. Given your average software developer salary and average range of options, it takes very little to actually hit AMT.
We help cover the exercise and any associated taxes for a portion of the upside!
Happy to help anyone thinking through these situations.
Put together some helpful resources and tools here: https://withcompound.com/equity
Some other useful guides:
https://www.holloway.com/g/equity-compensation
https://fortune.com/2016/09/27/the-complete-guide-to-underst...
1. Join a startup pre-Series A where the strike price is minimal because there hasn't been a priced equity round yet. Early exercise.
2. Join startups that support Extended Exercise Windows. https://github.com/holman/extended-exercise-windows
But I've also throughout my career aspired to be a skilled tradesman; I've tried to do a productive job well, rather than to try to lever myself up on the skills of others.
It hasn't made me rich (surprise!), but I'm happier than at least some of my colleagues who chose the more-enriching path.
And when I left I had more stock options than anyone else there. But, the fact that they didn't have more liquidity events and the fact that I couldnt sell more of my stock, is kinda of a red flag. If no one else in the market wants the investment (no liquidity events), it's usually a bad sign. It was a pretty easy decision to not buy the rest of it. I think most of my coworkers bought theirs. Of course, it turned out they were all worthless.
Also this gets the tax treatment totally wrong. It's not treated as regular income when you exercise, only AMT income. This is a huge difference because the large default AMT credit means that you can exercise a substantial amount without paying taxes.
https://slate.com/podcasts/slate-money/2019/08/slate-money-a...
No. Companies that are terrible workplaces can be great investments and vice versa.
That said I bought half the options of my last company because the strike price -> FMV was great enough to take the risk. However I consider that a gamble equal to rolling pass line in Vegas, and I didn't make the bet with money I needed to live on.
Note that if you just started you can likely "early exercise" all of your options right now by filing an 83B and paying the company the strike price. You generally have 90 days from the date of the option grant to do this.
The only benefit to exercising early is to avoid the AMT impact.
It's a risk, and as such, one should aim at a billion, not a million, that's what investors expect anyway. So by that logic, the return could be much much bigger.
Which matches my experience. Think about why you're leaving - probably for reasons which might help predict the company's future.
wait wait, no there are some valuable insights here:
> You make decisions based on what you know, not by looking at a crystal ball.
> I didn’t want to look back. [...] To me, the possibility of missing out on a big payday wasn’t worth the cost to my psyche.
