3 ms·
You have the gist right but a couple of corrections: 1) The board doesn't set the price arbitrarily. They engage a 3rd party accounting firm to do a 409A evalu
by harryh 10y ago
You have the gist right but a couple of corrections:
1) The board doesn't set the price arbitrarily. They engage a 3rd party accounting firm to do a 409A evaluation of the company. The 3rd party essentially sets the price. It's true that determining a market price for private company stock is just as much art as science but it's not completely arbitrary.
2) The company ABSOLUTELY CANNOT offer stock options at a discount to the 409A. There is a good chance people would go to jail these days if they did that.
3) The discount that you are talking about is the discount from preferred stock (which investors generally hold) and common stock (which employees generally hold). Preferred stock is legitimately more valuable because of various privileges attached to it that are not attached to common.
4) If you immediately exercise your stock upon granting you won't face an "exercise tax" interaction because the price at which you exercise will be the same as your strike price. If you can afford it this, is often a good idea. You have to file some paperwork with the IRS called an 83B to do this right.
5) It's when you wait some period of time that you can face an exercise tax. This is because over time the company will do additional 409As and if the company is succeeding those will indicate that common stock has risen in value. It's that difference that you might have to pay taxes on. It's this tax that this bill aims to let you defer.
- gshulegaard 10y agoSee I knew there would be someone else on here who knew better :) Anyway, my only elaboration on point 4 and 5 is that most options agreements have vesting ~~terms~~ schedules (and they typically include 1-year cliffs). So even under ideal conditions you will have to wait a certain amount of time before exercising. But thanks for taking the time to add additional details!
- harryh 10y agoYou can actually exercise before stock has vested. If you leave the company before your stock vests they have the option of buying it back from you.
- gshulegaard 10y agoInteresting...also good to know. Thanks!
- rlucas 10y ago> 2) The company ABSOLUTELY CANNOT offer stock options at a discount to the 409A. There is a good chance people would go to jail these days if they did that. Absolutely false. A company can create an option, a warrant, etc. with whatever kind of terms it likes, so long as the board approves and it's permitted by the applicable state law and charter. The only thing a 409(a) valuation does is provide a "safe harbor" for the company and the employee, that allows them both to rely on the valuation as fair market value for tax & accounting purposes (for the company, so that it doesn't need to expense the option; for the employee, so that there's not an immediate taxable gain upon vesting). The board, in fact, can make its own determination of fair market value without a 409(a) valuation. But if they do that, they blow their safe harbor and the burden of proof is on them if the IRS comes knocking. So no competent counsel is going to let you go around making up your own FMV. Finally, I'm pretty sure that a board could even issue options that didn't even pretend to be at FMV, but were at some unconstrained number. There's very good reason, for example, to issue out-of-the-money options when you want people to have skin in the game. There's probably some conceivable reason to issue an in-the-money option, too. (If you do this, though, you are likely condemning both your company and your optionee to a pretty dark slog through the thickets of tax law.) It is true that there were some criminal (and civil) sanctions tossed around for options shenanigans in the dot com 1.0 days, but they were mainly due to public companies blatantly back-dating options to specific days when the stock price was down, so as to provide guaranteed value to options recipients, without the company needing properly to account for the expense.
- harryh 10y agoOK ya, that's all fair. I overstated. I will amend my comment to say that if companies do offer options at a discount to the 409A everyone involved needs to be very very very careful about tax laws or bad things can happen to both the company and the option grantee.