Anecdotes don’t really matter much on this question. What matters is a) what information do you have at the time you quit b) how much capital do you have and c) what is your risk tolerance.
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.
Except that under US tax law, in that exact situation where you have options with a low strike price and the company's stock price has clearly increased significantly, the difference between the strike price and the stock price will be considered taxable income for the Alternative Minimum Tax (AMT) when you exercise.
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.
If your strike price is near 0 then you should have done early exercise with 83b election to avoid the AMT tax (if your company permits this of course).
This falls under the, "Do I have enough capital to make the purchase?" question. And if the company fails, you get to write all this off at the previously taxed price.
Definitely a factor to consider, but not dispositive.
But be careful with this: you can write off only $3000 per year of it against ordinary income. I knew someone during the dot-com bubble who had to take a mortgage to pay his AMT from buying his options, then the stock tanked and he could only write off this $3000 a year...
That's true, but it may take a while for the company to fail, and in the meantime, perhaps no one wants to buy your stocks. I think there might be some way to give them back to the company if they want to, but not being able to sell them, even for a loss, keeps the loss from being realized and therefore deducted as a capital loss.
Worth noting, even if you have an extended exercise window (i.e 10 years), your ISOs will turn into NSOs after 90 days since your departure (and thus have a different tax treatment!).
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.
Bankruptcy .... when people use the word 'restructuring' it typically refers to some sort of change in the capital structure/ownership where by equity and maybe even some of the debt is either wiped out, worthless.
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.
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 happened to me as an employee - during an acquisition we were force liquidated at a price that was just above strike. A few people made some money, but most people made a couple thousand dollars. A couple years later we all got checks in the mail for reimbursement on overage from tax withholding.
If CollabNet had given you stock instead of options as part of your comp package they would have ended up just as worthless as your (exercised) options.
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.
One factor for me would be if the company was aggressive enough in its 409a valuations of common stock.
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 :-)
That’s exactly what I was trying to say — specifically the 409a valuations for several companies I’ve been at were not appropriately reduced for common shares versus the preferred.
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.
> That’s exactly what I was trying to say — specifically the 409a valuations for several companies I’ve been at were not appropriately reduced for common shares versus the preferred.
Anecdata, but I have seen this too.
Can someone knowledgable founder here please chime in on why companies do this? Does the higher common price help the company boost its compensation packages to match those from AmaGoogFaceSoft who give publicly traded stock?
Aside from companies just not generally understanding the value of a low common stock valuation? They could mistakenly believe the low common valuation will impact a future funding round.
The value can creep up over time, and then companies try to avoid the perception that the common stock would ever become less valuable, so they also might try to keep it rising.
Or perhaps more dubiously, they could be quoting stock option grants in terms of dollar value of the strike price, and want it to look higher for the same number of shares. In an offer letter, which seems like a larger/better grant; 10,000 options at a $3.80 exercise price, or 10,000 options at a $0.38 exercise price? You will almost never see a percentage value quoted, and I've heard of some companies claiming the total share count is not even public information!
> One factor for me would be if the company was aggressive enough in its 409a valuations of common stock
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.
> This is not true if, like most stock options, yours are ISOs and you don't hit AMT.
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.
#1 is great for the cash outlay for exercising, but if the company has been even mildly successful with fundraising rounds then the spread will be significant and AMT could crush you.
I worked at a company from 2011 - 2013 that gave me the offer to buy out my options. I'm glad I didn't because that company was going out of business. The entire executive leadership team was swapped out 3 times over the course of 6 months by the board and we were getting crushed by competition. It was only a couple thousand dollars but I would have just lost it. The answer to this really depends on your situation and a lot of the points touched on in the post.
This is a question of risk-appetite. I'm with the OP (I think); I like safety. Age is a factor (I'm no spring chicken, and anyway I can't wait that long for stuff to mature).
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.
I worked at a startup for 5 years. the company recently had been valued at 700Million but only had 1 secondary offer, where I sold as much stock as they would let me (15% ~ worth roughly 6k pretaxes).
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 remember in these situations its usually not all or nothing. You can buy half your options, or just a fraction. That makes the choice less stressful.
Stock options are often for common stock and if its in a VC backed company, the VC's will invest in the form of preffered equity which is like permanent debt with no interest payments. If the company is sold for 20% less than the last round, the VCs will be paid first and the common equity gets what is left over which could be 20%, 50%, 100% lower than what you thought you might get. So be careful....
If the 409a price is greater than the strike price, of course you exercise. If you don't want to hold it just sell it back to the company.
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.
If you are at a startup and decide to leave doesn't that also mean that you don't believe in the company anymore? I understand that there are always cases like better position or other personal issues that make people move but for the most part the original statement holds true. So you don't buy out the stock options and move on.
Short answer, from experience: unless the company is on a clear track to a liquidation event, no.
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.
Are there tax benefits to exercising early? Hypothetically say I have some options with a pretty cheap exercise price, and I think the company will be taking on PE money in the near future, AND I have faith that the company will successfully exit in the future, will exercising early save me some taxes?
Yes. If you can exercise at a low price then all of your gains after that will be taxed at capital gains rates instead of ordinary income rates.
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.
This is not correct, and I'm not sure why you would think this. In general the way to think about capital gains is that you can't qualify for them unless you have purchased something that then appreciates in value.
So for stock options, you don't start the clock on the long term capital gains rate or set a cost basis for your capital gain until you exercise the option and shell out the cash for the strike price.
There is all kinds of information on the internet about this if you don't believe me.
I'm talking about incentive stock options (ISO), which is the most common thing to get. Non-statutory stock options (NSO) are entirely different and are not common for normal startup employees.
When you exercise ISOs, you are buying the stock at the strike price. It doesn't matter what the current market price of it is (other than for AMT). The cost basis is the strike price.
The "clock" for determine long-term vs short-term starts when you exercise, but it doesn't affect the cost basis. If you don't hold it long enough the gain may get taxed as short-term or ordinary income (usually no a difference except in a couple of states).
If the company qualifies as Small Business (see QSBS,, Qualified Small Business Shares) at the time you buy your shares (not vest), then there is no federal taxes at all (up to 10 millions).
"What’s 75%, of half a percent, of a million dollars? $37,500"
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.
funny, I have actual full shares of an old company I used to work for (got the shares at a discount instead of options), but I'm still waiting for the phone call telling me I'm rich.
I wish this would get discussed in the context of options that actually would be worth something, just once. Seems like a much easier decision when you’re talking about a company that hasn’t experienced much interesting growth and is likely not going anywhere.
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.