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The main difference would be the strike price of the options, which can make a huge difference in both taxes and income at a liquidity event. Assuming the compa

The main difference would be the strike price of the options, which can make a huge difference in both taxes and income at a liquidity event. Assuming the company is growing over time, you absolutely want option 1. The strike price is determined by a 409a evaluations. Example: assume the valuations each year are 0.10, 0.20, 0.30, 0.40, 0.50 and the sale price is $1 at year 5. In option 1 your strike price will be $0.10 for all 100 options so should you choose to exercise you have to pay $10, netting you $90. You can choose to exercise these as they vest, paying $2.50 each year. If you choose to exercise on vest, your cost is the same, although you potentially will owe AMT. This means that if you make enough money you essentially have to declare the difference between strike price and current value as income. This means you will have to potentially pay taxes on an extra $25 over the four years. In option 2, exercising the options will require $5.00, $7.50, $10, $12.50 for a total of $35. This means you only make $65 in the sale.

areyousure 11y ago
Why can't the options have a strike price of 0.10 in option 2? (I assume I should look up "409a", the magic keyword to answer my questions?)
- deleted 11y ago
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- vishvananda 11y ago
  Yes once upon a time companies could set whatever they wanted for the strike price but not anymore. I think there might still be a way to do it with complex bookkeeping but AFAIK everyone just uses the 409a value.
areyousure 11y ago
And just to see if I understand correctly, if you exercise on vest, you have an extra $25 of taxable income over the four years, but then $25 less at year 5? There is no sense in which you have more taxable income; its distribution over time has merely changed.
- vishvananda 11y ago
  Actually your taxable income in the second case is less because you made less money. :)
  - areyousure 11y ago
    How can you make less money by exercising the same options, but at a different time?
    - vishvananda 11y ago
      when you declare your income you subtract your cost basis from the sale price. In 1 you paid $10 and sold for $100 = $90 profit you have to pay taxes on. In 2 you paid $35 and sold for $100 = $65 profit. It isn't the time at which you exercise that makes the difference, it is the higher strike price. EDIT: to be clear, 1 and 2 refer to the original differences in the first post. If we are comparing different exercise time with the same strike price, then the taxes are nominally the same (Because the income tax % you pay depends on your income, you might be able to save money by exercising in a year when your income is low).
    - dllthomas 11y ago
      The answer is that they're not the same options. Your respondents are assuming the strike price is FMV at the time the options are issued, which will be different at different times. There may be good reason for that assumption, if it's somehow prohibited to later issue options based on an earlier FMV, but it should have been called out because it's changing more things than just what you'd intended to ask about.

areyousure 11y ago

Why can't the options have a strike price of 0.10 in option 2? (I assume I should look up "409a", the magic keyword to answer my questions?)

deleted 11y ago
[deleted]
vishvananda 11y ago
Yes once upon a time companies could set whatever they wanted for the strike price but not anymore. I think there might still be a way to do it with complex bookkeeping but AFAIK everyone just uses the 409a value.

areyousure 11y ago

And just to see if I understand correctly, if you exercise on vest, you have an extra $25 of taxable income over the four years, but then $25 less at year 5? There is no sense in which you have more taxable income; its distribution over time has merely changed.

vishvananda 11y ago
Actually your taxable income in the second case is less because you made less money. :)
- areyousure 11y ago
  How can you make less money by exercising the same options, but at a different time?
  - vishvananda 11y ago
    when you declare your income you subtract your cost basis from the sale price. In 1 you paid $10 and sold for $100 = $90 profit you have to pay taxes on. In 2 you paid $35 and sold for $100 = $65 profit. It isn't the time at which you exercise that makes the difference, it is the higher strike price. EDIT: to be clear, 1 and 2 refer to the original differences in the first post. If we are comparing different exercise time with the same strike price, then the taxes are nominally the same (Because the income tax % you pay depends on your income, you might be able to save money by exercising in a year when your income is low).
  - dllthomas 11y ago
    The answer is that they're not the same options. Your respondents are assuming the strike price is FMV at the time the options are issued, which will be different at different times. There may be good reason for that assumption, if it's somehow prohibited to later issue options based on an earlier FMV, but it should have been called out because it's changing more things than just what you'd intended to ask about.