Can I use a retirement fund to buy out startup stock options?
November 17, 2009 7:25 PM   Subscribe

I'm about to leave a startup to go to a different company, and I need some help figuring out how to handle my stock options.

I currently work for a startup at which I have accrued X stock options at a price of $Y. From the date I leave, I have 90 days to buy out the options. I don't currently have the cash on hand to do this, but I do have approximately X*$Y in my 401k, which I would have to roll over either to the new company's 401k or to an IRA.

I think I heard that you can buy out options like this in a retirement fund, but if this is true I need to better understand the details and mechanics of it. Is anyone familiar with this situation who can tell me what to look for? Are there specific types of IRAs or anything like that which would give me more flexibility? What do I need to know?

For what it's worth, I do believe the startup will succeed; I'm leaving because my job there is not what I want. Also, I'm in my mid-twenties. So I am not concerned about using my (currently minimal) retirement fund to buy these out.
posted by anonymous to Work & Money (7 answers total)
You really need to speak with a qualfed accountant about this. There are all mannner of tax issues that arise from stock options.

And by accountant I don't mean H&R Block. I mean a qualified accountant.
posted by dfriedman at 7:31 PM on November 17, 2009

This is too complicated for AskMe (and I am someone who works in a field related to these sort of issues). Speak to a qualified accountant as dfriedman suggests.
posted by Falconetti at 7:36 PM on November 17, 2009

I'd actually look into a law firm as they should be able to take care of you. This should be fairly straightforward once they took a look at what you signed.
posted by geoff. at 8:13 PM on November 17, 2009

Other consideration:

Irrespective of all the tax issues, how confident are you that your current startup employer will exit successfully, either through IPO or sale of the firm? Furthermore, how far along is the company? Could you comfortably sit on this investment for the years it might take for such an exit to occur?

If you're exercising your options in this way, you are making a pretty significant bet on the company doing exiting - if it doesn't happen, you run the risk of being out. And exits don't always happen quickly - while entrepreneurs and VC firms always hope for the 2-4 year turnaround, there are plenty of VC-backed ventures that have been going along for more than a decade without exit - market conditions have been less than ideal.
posted by swngnmonk at 8:21 PM on November 17, 2009

When I had similar questions, I used Thompson & Knight to help me figure it all out. They are not an inexpensive option, but they are amazingly good in their practice arenas.

You need a lawyer or a CPA or both. This is a pretty complex area both from the stock standpoint (i.e., viability of the options as swngmonk mentioned) and from a tax perspective.
posted by dejah420 at 9:25 PM on November 17, 2009

Start-ups are pretty risky investments especially for the common share holders (employees). I would think long and hard about investing any cash in start-up common stock especially if the company is pre-breakeven.

If the company will need to raise more cash from investors then there is always a significant risk that the existing shareholders can get a very raw deal if the new valuation is less than the previous one (a "down" round). I have seen people lose good money because they exercised options that were wiped out in a later round.

As a start-up CEO, I would advise you that unless the company is already profitable and you're sure it won't need to raise more investment, keep your cash. The risk is probably the same as putting it all on red in Vegas.
posted by Long Way To Go at 1:34 AM on November 18, 2009 [1 favorite]

The key question unaddressed here are whether or not you think your options are significantly "in the money" or not.

If you think the strike (ie, exercise) price of your options is roughly equivalent to the value of the stock, then it probably does not make sense to exercise your options because you would effectively be betting on the future of the company at par and you would be tied up in an illiquid investment for sometime, possibly forever.

If you think the strike price of the options is far below the value of the stock, then exercising (or partial exercising) might make sense, if the financial opportunity is too lucrative to pass-up.

While valuing the company might be difficult if not impossible if it is a start-up, one measure you could use would be to find out what strike price current options have. For example, if your option package from when you first joined was at a $1 strike price, and current options are being given out at $5 strikes, that most likely tells you that management believes the stock today is much more valuable than when your options were granted (unless they are purposely granting them far out of the money). On the other hand, if current option grants are the same as yours, that tells you that management believes the equity hasn't appreciated yet.

Another thing for you to consider might be finding a wealthy friend to help finance your option exercise for some share of the upside.

In any case, you should seek professional assistance beyond the capacity of this forum.
posted by jameslavelle3 at 8:39 AM on November 18, 2009

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