Early exercising is a good idea when you either have high confidence that the company will have a successful exit or the total cost to exercise is affordable.
Understanding Startup Stock Options
This approach has 2 major advantages:. Facebook Twitter Linkedin. What is a Stock Option? Understanding the Equity Component of an Offer There are a few key components to an equity offer that you should always look for. Number of Options.
The number of shares you have the right to purchase. Percentage Ownership. Strike Price. The per-share price that you pay to exercise your options. Vesting Schedule.
A typical vesting schedule is four years with a one-year cliff. One meaningful downside to the company of allowing optionholders to early exercise is that the company can face disputes with optionholders who neglect to make this filing. Such optionholders might fault the company for not giving adequate notice of the deadline, or of the consequences of failing to file, or might even expect the company to handle the filing for them.
Navigating Startup Equity: How and When to Exercise Your Shares
The time and cost of educating optionholders about the 83 b election, coupled with the potential for disputes with people who might not complete their filing in time is enough for many companies to steer away from allowing early exercise. If the optionholder early exercises, the company will retain the right to repurchase the stock that is unvested when the optionholder terminates service.
The repurchase price is generally the lower of the exercise price or the then-current fair market value of the stock. This repurchase right will lapse as the stock vests. Companies generally would not have the right to repurchase any of the vested stock. The company generally holds the unvested stock in escrow to facilitate the repurchase in the event the person leaves the company, and also collects from the optionholder at the time of exercise all of the signed documents that would be required to re-sell the unvested shares back to the company.
Should a Startup Allow Early Exercise of Stock Options? - Capbase
The company only uses those documents if and when the person leaves the company while holding unvested shares. Document Generator. Thank you.
Thank you for reaching out to us. This means you should try to minimize the difference between the strike price and exercise price — at a successful startup, this equates to exercising ASAP. Now, say you decide to leave the company at Year 3, and that like most startups, your company requires departing employees to exercise their options within 90 days. When does exercising as you vest go wrong? Like making an 83 b election, immediate exercising goes south if your startup fails.
Cash flow Reason number two: Take a look at the taxable income in Year 3. Combine that with the possibility of a lower salary when you leave your job, and you may not have enough cash on hand to pay your tax bill. If your startup is failing, exercising your options will be a waste of money. If you can afford the total cost of exercising and believe that your shares will be worth much more down the line, go for it. Such loans can come from the company itself in the form of a promissory note, often with the stock for collateral , specialized lenders, or more traditional institutions like banks, online loan marketplaces or credit cards though this last comes with prohibitively high interest rates and is almost never a good idea.
The downside, though, is pretty significant. Net exercise If you want to avoid the risk of taking out a loan or promissory note, you can make a net exercise — basically, selling some stock back to the company to cover the cost of your options. When it comes time to exercise, your startup will determine the current FMV of your options, then reduces the number of shares issued to you by the cost of exercise which includes tax withholdings, if you have non-qualified stock options.
Restricted Stocks or ISOs?
If you wanted to make the transaction without paying anything, you could do a net exercise. Your 3, shares will be yours free and clear, and your taxes will already be taken care of. Cashless exercises are more common with public companies, but can be done with private companies with a secondary market for their shares — usually, this translates to large, highly sought-after startups.
However, there are two downsides to keep in mind.