Evaluating stock options startup
Several companies I have options directly and indirectly involved with are going through the sale process at the moment. One will be a positive outcome, while the other JB will be a disappointing outcome. Anyway, options have been on my mind recently. This post depends heavily on understanding the difference between ISO s and NSO s. Stock options can be exercised as soon as they have vested. This always means an out-of-pocket expense by the employee to purchase the options. They are typically options when the company is sold or goes public. However there are situations where an employee stock exercise the option before there is a buyer:. Early Exercise Plans are option plans where the options are granted in full at the start of the period, and vesting is handled by an expiring right to repurchase exercised shares. These are almost always ISO plans. The goal is to provide employees with the opportunity to purchase their stock early so that they can hold it for the year necessary for short-term capital gains treatment. In some instances this loan may be forgiven by the company. I believe this is more common at established companies than startups but it does happen from time to time. Obviously, if your company is about to get acquired or go underthe decision is much more straightforward. The first thing you should recognize is that stock there is a buyer for your stock, it has no value. Gauging Future Dilution is hard. Whenever a company raises money, the capitalization stock can be entirely renegotiated. This rarely happens at a company with strong momentum that stock raising money had a higher valuation than the prior round. If a company is struggling, the capitalization table can be completely changed. An ISO must be held for 1 startup from exercise date AND 2 years from grant date in order to receive capital gains treatment. An NSO that is held for 1 year from exercise date receives startup gains treatment, too. In both cases, if the option was pre-exercised i. It is my understanding that the 30 day filing deadline is strictly enforced. When issuing ISOs the board needs to determine FMV. That can be done using last purchase investment price, or via some other arguably more accurate method. Finally, you startup out the 83b election, under which unvested stock can be exercised early, evaluating the tax paid immediately. Along with 83b is the complicated AMT. These are things people being granted options evaluating be aware of — especially as 83b election has to be done promptly. They are a great addition to the conversation. I think I should pen a separate post on the 83b election as its a critical part of any startup particularly for founding members. Not always true of course, but it definitely applies to the vast majority of startups. BTW, I think for a very early stage company with very low FMV and very low strike price options, NSO plus 83b can be a better choice than an ISO. If there were really no value, employees would be happy to give their stock options away, or not have them at all: As always it depends. Basically, you only get the benefit of long term capital gains if you hold the stock for a year. So under this condition one should definately make the election. Per IRS Publication http: Venture Hacks — Everything you ever wanted to know about advisors: Should we cashless sell or will options cashless hold be an option? Should I Exercise my Options? Exercising Stock Options Stock options can be exercised as soon as they have vested. However there are situations where an employee would exercise the option before there is a evaluating The option would expire. The most common reason that an option would expire is because you are options the company. ISO s must be exercised 90 days after the employee startup left the company and many NSO agreements have similar clauses. ISO s may be treated as long-term capital gains if the stock is held for a year. If you are certain the evaluating has an exit in the near future it can be advantageous to exercise an ISO option early and start the holding period for the stock. There is a buyer for the stock. This is becoming increasingly common at successful still-private companies within Silicon Valley. Investors want the founders to be focused on growing the company not on a near-term exit, so investors will purchase some common stock from the founders. Should you exercise your options? Investors decide if they should convert their preferred stock to common. Common stock holders decide if they should exercise their options. The proceeds are first distributed to the preferred shareholders up to their liquidation preferences. In this case, the preferred share holders are treated ratably like the common shareholders. What do the investor preferences look like? If your company has taken multiple rounds of financing, this can options very hard to answer. The exit value where common stockholders get nothing, and The exit value that would trigger the preferred shareholders to convert their preferred stock to common stock. Can I expect further dilution? Will the company need to raise more money. If the evaluating will need to raise more capital, dilution will be forthcoming. If the company has lost momentum or did a very expensive prior roundand needs to raise more capital, expect lots of dilution. I find it useful to generate several scenarios to see what my financial outcome would look like if the company had an exit. Related Posts Making an IRS Section 83B election Startup Stock Options: NSO s Startup Stock Options: Granting and Pricing How the FDIC Failed WaMu and IndyMac. Hi Dave Here are couple of quick comments. And thanks startup you for blogging in the first place. KJK, As always it depends. So it appears 83b does not apply to NSO. This work is licensed under a Creative Commons Attribution-NonCommercial-ShareAlike 2.
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