Raise or fold?
September 20, 2012 5:10 PM Subscribe
Should I exercise my time-limited stock options? I can afford it, but not without unease. I think it's a probably a good investment, but I have trouble determining how good. Details within.
I worked for a startup, then left about half a year ago. Today, I was informed that some of my options have vested, but I have to exercise them in 90 days.
The decision is difficult because I think it's likely that they will either issue an IPO or be bought, but I really can't quantify how likely this is. If they do, the ROI is big, even if it the price is $1/share. If they don't, I don't get anything. But without being able to make a reliable guess at how likely, it's hard to assess the value.
Other facts of the case:
- The strike price is about $0.25 per share. I have options for about 5000 shares.
- It is a competently run, profitable company that has stated to its employees that it plans to go public someday. (I realize that a million companies have made and broken this promise, and in fact, worked at one of them for several years.)
- The CEO taken his previous companies public or sold them. None of them have been driven into the ground.
- I'm in a sort of fixed income situation. I have been working on a project since leaving the company that is still not completed and not making any money. My spouse (who also does not know exactly how to decide this case) has been earning income that's covered our expenses, and savings remains fairly unaffected. (I am fairly confident that I can get work once my project wraps.) Using $1250 to exercise the options would not take food out of anyone's mouth, but it does make me uneasy.
Should I let this go? Should I get on this?
I worked for a startup, then left about half a year ago. Today, I was informed that some of my options have vested, but I have to exercise them in 90 days.
The decision is difficult because I think it's likely that they will either issue an IPO or be bought, but I really can't quantify how likely this is. If they do, the ROI is big, even if it the price is $1/share. If they don't, I don't get anything. But without being able to make a reliable guess at how likely, it's hard to assess the value.
Other facts of the case:
- The strike price is about $0.25 per share. I have options for about 5000 shares.
- It is a competently run, profitable company that has stated to its employees that it plans to go public someday. (I realize that a million companies have made and broken this promise, and in fact, worked at one of them for several years.)
- The CEO taken his previous companies public or sold them. None of them have been driven into the ground.
- I'm in a sort of fixed income situation. I have been working on a project since leaving the company that is still not completed and not making any money. My spouse (who also does not know exactly how to decide this case) has been earning income that's covered our expenses, and savings remains fairly unaffected. (I am fairly confident that I can get work once my project wraps.) Using $1250 to exercise the options would not take food out of anyone's mouth, but it does make me uneasy.
Should I let this go? Should I get on this?
If you can afford to lose $1,250, go for it.
Worst case, the shares decline to $0 and you have a tax write-off.
posted by dfriedman at 5:20 PM on September 20, 2012 [2 favorites]
Worst case, the shares decline to $0 and you have a tax write-off.
posted by dfriedman at 5:20 PM on September 20, 2012 [2 favorites]
It is a competently run, profitable company...
The CEO taken his previous companies public or sold them. None of them have been driven into the ground.
These are very strong indicators. In your shoes there's no question I would exercise the options.
posted by alms at 5:31 PM on September 20, 2012 [5 favorites]
The CEO taken his previous companies public or sold them. None of them have been driven into the ground.
These are very strong indicators. In your shoes there's no question I would exercise the options.
posted by alms at 5:31 PM on September 20, 2012 [5 favorites]
Frankly I'm with alms, but just so you know: it isn't an all-or-nothing situation; you can exercise half the options for $625 and let the rest expire if it is really the amount of the initial investment that is giving you pause.
posted by Joey Buttafoucault at 5:37 PM on September 20, 2012
posted by Joey Buttafoucault at 5:37 PM on September 20, 2012
Do some homework. Find out how many shares have been issued if possible. Then take a guess at a reasonable valuation for the company based upon what it does and what it might do in the future. This should allow you to estimate how much your shares might be worth at an IPO. If you don't know the valuation just use a big number as the best possible scenario ($10M, $1B, $10B).
Once you have a best case for your shares this is a much easier problem to solve. If you have the potential of millions of dollars you owe it to yourself to at least exercise a fraction of the shares. If you have the best case potential of only $10000, then the $1250 investment is still great if it pays off, but you won't be kicking yourself in 30 years for passing up the option...
If you really can't decide contact the company and ask some questions. I suspect they will be reasonably forthcoming with the information you need to make the decision. They certainly won't tell you the company financials, but you might find they want to buy back your options right now or that they can tell you the current price of the shares on the private market (if they trade...)
posted by NoDef at 5:57 PM on September 20, 2012
Once you have a best case for your shares this is a much easier problem to solve. If you have the potential of millions of dollars you owe it to yourself to at least exercise a fraction of the shares. If you have the best case potential of only $10000, then the $1250 investment is still great if it pays off, but you won't be kicking yourself in 30 years for passing up the option...
If you really can't decide contact the company and ask some questions. I suspect they will be reasonably forthcoming with the information you need to make the decision. They certainly won't tell you the company financials, but you might find they want to buy back your options right now or that they can tell you the current price of the shares on the private market (if they trade...)
posted by NoDef at 5:57 PM on September 20, 2012
buying your options is usually a measure of if you trust the management or not. do you? then, do the basic math outlined above (% of outstanding and expected value).
I think $1250 for a high upside with worst case being a small writeoff is a no-brainer, given a reasonable chance of success. 10% chance of payout where that would be $20k before taxes gets you about even odds, and so on.
posted by kcm at 6:05 PM on September 20, 2012
I think $1250 for a high upside with worst case being a small writeoff is a no-brainer, given a reasonable chance of success. 10% chance of payout where that would be $20k before taxes gets you about even odds, and so on.
posted by kcm at 6:05 PM on September 20, 2012
Having been in a similar situation before, I recommend exercising your options. You may miss the $1250 if the company goes belly up, but you will really consider yourself dumb if you end up missing a chance to make a lot more than that.
In general I also recommend exercising some fraction, even if you don't go for all the options. I had spent a few hundred dollars exercising a part of options that I had at one startup once, and years later made a few thousand dollars. I could have made twice as much, but at least I didn't feel I missed out on it completely.
posted by haykinson at 11:28 PM on September 20, 2012
In general I also recommend exercising some fraction, even if you don't go for all the options. I had spent a few hundred dollars exercising a part of options that I had at one startup once, and years later made a few thousand dollars. I could have made twice as much, but at least I didn't feel I missed out on it completely.
posted by haykinson at 11:28 PM on September 20, 2012
You will want to find out the following things, and so will I so I can help you.
Tomorrow, call up the company or email the CFO and ask:
Dear CFO, 1) what is the current fair market value of the shares, and 2) how many shares are outstanding?
You want to know (1) because:
a) it tells you how much income tax you'll have to pay purchasing these shares (income is your 'profit', which is only on paper, but is the fair market value minus the strike price).
b) it also tells you how awesome the most recent investors think the company is, because they almost certainly had to pay that fair market value price to invest.
You want to know (2) because it allows you to know your percentage of the company, and thus to back of the envelope calculations on your future filthy riches (or lack thereof) in various scenarios.
Specifically, if you own say 10% of the outstanding shares and the company is acquired for $300M, your payday would be 10% of that or $30M.
If you want to add in the "this company may collapse or be worthless" odds of 9 in 10, then take 10% (the odds of success) of that payday above as your average expected payout.
tl;dr - we can't tell you if this investment is a good buy or not until we know: 1) how much it will cost you in taxes, and 2) how much the company is likely to be worth. Answering those questions above will help us do that.
posted by zippy at 2:15 AM on September 21, 2012 [1 favorite]
Tomorrow, call up the company or email the CFO and ask:
Dear CFO, 1) what is the current fair market value of the shares, and 2) how many shares are outstanding?
You want to know (1) because:
a) it tells you how much income tax you'll have to pay purchasing these shares (income is your 'profit', which is only on paper, but is the fair market value minus the strike price).
b) it also tells you how awesome the most recent investors think the company is, because they almost certainly had to pay that fair market value price to invest.
You want to know (2) because it allows you to know your percentage of the company, and thus to back of the envelope calculations on your future filthy riches (or lack thereof) in various scenarios.
Specifically, if you own say 10% of the outstanding shares and the company is acquired for $300M, your payday would be 10% of that or $30M.
If you want to add in the "this company may collapse or be worthless" odds of 9 in 10, then take 10% (the odds of success) of that payday above as your average expected payout.
tl;dr - we can't tell you if this investment is a good buy or not until we know: 1) how much it will cost you in taxes, and 2) how much the company is likely to be worth. Answering those questions above will help us do that.
posted by zippy at 2:15 AM on September 21, 2012 [1 favorite]
If you can afford to lose $1,250, go for it.
Worst case, the shares decline to $0 and you have a tax write-off.
I do not think this is the worst case.
I think the worst case is this: you pay $1,250 for shares that have a fair market value of $100,000, then there is no liquidity event and you still owe the IRS taxes on your paper gain of nearly $99,000 ($100,000 - $1,250).
posted by zippy at 2:19 AM on September 21, 2012 [2 favorites]
Worst case, the shares decline to $0 and you have a tax write-off.
I do not think this is the worst case.
I think the worst case is this: you pay $1,250 for shares that have a fair market value of $100,000, then there is no liquidity event and you still owe the IRS taxes on your paper gain of nearly $99,000 ($100,000 - $1,250).
posted by zippy at 2:19 AM on September 21, 2012 [2 favorites]
What zippy said. If the shares are "worth" about $2 apiece, say (because for example external investors have valued the company at that level), then this year you'll have to pay taxes on the virtual "profit" you made by buying $10,000 worth of shares for $1,250, even though you have no way of actually seeing that profit until the company is bought or goes public. Definitely find out what the fair market value of the stock is.
posted by dfan at 5:59 AM on September 21, 2012 [1 favorite]
posted by dfan at 5:59 AM on September 21, 2012 [1 favorite]
I believe zippy and dfan are confused and that you don't have to pay taxes on the virtual profit if the stock isn't liquid. It's worth looking into, though.
(There are certainly many people who get screwed by the tax implications of exercising options. This came up a lot during the dot com boom/bust: someone would exercise options generating a paper profit of $500K, but then failed to sell enough stock to cover the taxes. Later the stock tanks but they still owe the taxes from the point at which they exercised the options. I believe that scenario only occurs, though, when the stock is tradable.)
posted by alms at 8:20 AM on September 21, 2012
(There are certainly many people who get screwed by the tax implications of exercising options. This came up a lot during the dot com boom/bust: someone would exercise options generating a paper profit of $500K, but then failed to sell enough stock to cover the taxes. Later the stock tanks but they still owe the taxes from the point at which they exercised the options. I believe that scenario only occurs, though, when the stock is tradable.)
posted by alms at 8:20 AM on September 21, 2012
Last time I was in an early stock situation, we were given pieces of paper and told that if we did nothing else with the IRS this year we absolutely positively had to file these pieces of paper so that we didn't end up paying the difference on our stock until we sold it. In fact, I still have those pieces of paper sitting in the folder related to that company, not that I think that stock will ever be worth anything.
Soooo, talk with your CFO or HR person about what that form is and how you file it should you exercise to make sure that you're not generating a tax liability but, yes, I'd have the conversation about valuation, and then I'd be likely to buy the stock. Do you believe the company is going somewhere, or not? Twelve hundred bucks isn't a whole lot of money to the company, so someone believes that this is a way to give you some recompense. If you don't trust their judgement, you should probably be job hunting anyway.
posted by straw at 8:43 AM on September 21, 2012
Soooo, talk with your CFO or HR person about what that form is and how you file it should you exercise to make sure that you're not generating a tax liability but, yes, I'd have the conversation about valuation, and then I'd be likely to buy the stock. Do you believe the company is going somewhere, or not? Twelve hundred bucks isn't a whole lot of money to the company, so someone believes that this is a way to give you some recompense. If you don't trust their judgement, you should probably be job hunting anyway.
posted by straw at 8:43 AM on September 21, 2012
If it were me and I believed in the company, I'd risk the $1250 to exercise the options. There's a real chance your investment will end up being worth $0 or languishing illiquid for years in a zombie company. But there's also a chance that you bought a lottery ticket worth $10,000+. It's impossible to judge those odds without knowing anything about the company. Even knowing a lot about the company it's difficult; startups are risky investments.
A second concern isn't the $1250 in capital, it's the potential immediate tax burden. Depending on the type of options you have, you may owe income tax or AMT, particularly if the fair market value of the stock is more than your $0.25 strike price. This thread already has at least two misstatements about how income taxes work on a stock option exercise. You need to ask an accountant or become an expert yourself. A key thing you need to know to understand the tax implications is whether they are incentive stock options, non-qualified stock options, or some other thing.
posted by Nelson at 8:47 AM on September 21, 2012 [1 favorite]
A second concern isn't the $1250 in capital, it's the potential immediate tax burden. Depending on the type of options you have, you may owe income tax or AMT, particularly if the fair market value of the stock is more than your $0.25 strike price. This thread already has at least two misstatements about how income taxes work on a stock option exercise. You need to ask an accountant or become an expert yourself. A key thing you need to know to understand the tax implications is whether they are incentive stock options, non-qualified stock options, or some other thing.
posted by Nelson at 8:47 AM on September 21, 2012 [1 favorite]
This thread already has at least two misstatements about how income taxes work on a stock option exercise. You need to ask an accountant or become an expert yourself. A key thing you need to know to understand the tax implications is whether they are incentive stock options, non-qualified stock options, or some other thing.As one of the people who may have made one of those misstatements (I went through this process myself a few years ago but am not otherwise an expert), I second the advice to ask a tax accountant.
posted by dfan at 9:04 AM on September 21, 2012 [1 favorite]
I believe zippy and dfan are confused and that you don't have to pay taxes on the virtual profit if the stock isn't liquid.
Believe me, you can absolutely be taxed on illiquid stock. I admit I don't know what the rules are for different types of options, but the dot com options I received were absolutely taxable while locked up.
I've been there twice, and I had a co-worker who allegedly went underground from the IRS for years as a result of a tax hit that would have wiped out all of his liquid assets.
In the US, the IRS cares about the following: if you buy something for less than its value, then you have profited, and that profit is taxable (as capital gains).
Consider the following:
Newco offers employee 1000 options at a strike price of $1 each. The strike price is set, normally, at the current fair market value (FMV) at the time of the option grant. The FMV is usually, in the dot com scenario, the price an outside investor paid for shares in the company.
Now here are two scenarios, one where the employee is ok, and the other where they are screwed.
Scenario 1:
Employee exercises options, before Newco receives any additional investment, perhaps via an 83(b) election where they can "pre-exercise" the options. Now they have locked in a transaction where there is no gain. They own, or will own, the stock at a value of $1 a share. Fair market value - purchase price, at acquisition, = $0. $0 * 1000 shares = $0, no taxes, even if the shares go up, until the employee sells them.
Scenario 2:
Employee waits to exercise, the company gets a new round of investment, and the FMV of the stock is now set at $11/share. Hooray! The company is on the right track! Employee now exercises options. Gain per share is FMV - strike price: $11 - $1 = $10/share, for a total paper gain of $10,000.
This gain is taxable.
Even if the company prohibits employees from selling shares (say, they were just acquired, and there's a lock-down phase on insider sales, where a sale would result in an immediate firing).
Even if there is no market for the shares because the company is private.
The IRS doesn't care.
What they care about is that you bought something for less than it was worth, and profited, even if only on paper.
tl;dr - if you get hired early on at a company you believe in, and you can afford to buy the shares, do so immediately, via 83(b) election, before they go up in value, to avoid getting taxed on something you cannot sell. If FMV = purchase price, then there's no tax.
Also, if you haven't pre-purchased your shares, and you quit of get laid off, you will typically have 30 - 90 days to purchase vested options, and you will have to pay tax if FMV > strike price. There's nothing less fun than getting a huge tax hit when unemployed.
tl;tl;dr;dr - again, had you pre-purchased your options, you would have been ok.
posted by zippy at 9:21 AM on September 26, 2012
Believe me, you can absolutely be taxed on illiquid stock. I admit I don't know what the rules are for different types of options, but the dot com options I received were absolutely taxable while locked up.
I've been there twice, and I had a co-worker who allegedly went underground from the IRS for years as a result of a tax hit that would have wiped out all of his liquid assets.
In the US, the IRS cares about the following: if you buy something for less than its value, then you have profited, and that profit is taxable (as capital gains).
Consider the following:
Newco offers employee 1000 options at a strike price of $1 each. The strike price is set, normally, at the current fair market value (FMV) at the time of the option grant. The FMV is usually, in the dot com scenario, the price an outside investor paid for shares in the company.
Now here are two scenarios, one where the employee is ok, and the other where they are screwed.
Scenario 1:
Employee exercises options, before Newco receives any additional investment, perhaps via an 83(b) election where they can "pre-exercise" the options. Now they have locked in a transaction where there is no gain. They own, or will own, the stock at a value of $1 a share. Fair market value - purchase price, at acquisition, = $0. $0 * 1000 shares = $0, no taxes, even if the shares go up, until the employee sells them.
Scenario 2:
Employee waits to exercise, the company gets a new round of investment, and the FMV of the stock is now set at $11/share. Hooray! The company is on the right track! Employee now exercises options. Gain per share is FMV - strike price: $11 - $1 = $10/share, for a total paper gain of $10,000.
This gain is taxable.
Even if the company prohibits employees from selling shares (say, they were just acquired, and there's a lock-down phase on insider sales, where a sale would result in an immediate firing).
Even if there is no market for the shares because the company is private.
The IRS doesn't care.
What they care about is that you bought something for less than it was worth, and profited, even if only on paper.
tl;dr - if you get hired early on at a company you believe in, and you can afford to buy the shares, do so immediately, via 83(b) election, before they go up in value, to avoid getting taxed on something you cannot sell. If FMV = purchase price, then there's no tax.
Also, if you haven't pre-purchased your shares, and you quit of get laid off, you will typically have 30 - 90 days to purchase vested options, and you will have to pay tax if FMV > strike price. There's nothing less fun than getting a huge tax hit when unemployed.
tl;tl;dr;dr - again, had you pre-purchased your options, you would have been ok.
posted by zippy at 9:21 AM on September 26, 2012
Like Nelson said, this stuff is tricky. You either pay an expert or become one. Nearly every smart, quant-oriented engineer I know of has had trouble negotiating this maze, because they haven't been here before, taxes are boring, and besides, a law that taxes you something when you cannot sell it is ridiculous.
But there it is.
posted by zippy at 8:38 PM on September 26, 2012
But there it is.
posted by zippy at 8:38 PM on September 26, 2012
This thread is closed to new comments.
posted by michaelh at 5:18 PM on September 20, 2012