4 ms·
> This is why companies with skyrocketing valuations are particularly dangerous for employees. Shelling out tens or hundreds of thousands of dollars is hard eno
by 7Figures2Commas 11y ago
> This is why companies with skyrocketing valuations are particularly dangerous for employees. Shelling out tens or hundreds of thousands of dollars is hard enough for most. You can imagine needing to pay millions of dollars to acquire your options when you don’t have it.
Huh? The exercise price for options is established when employees are granted stock options, which almost always occurs at the beginning of employment. Employees can calculate the total cost of exercise based on the information contained in the Notice of Stock Option Grant. You can and should ask for this information before you join a company.
If you are granted 100,000 options with an exercise price of $0.20, you know that the total cost of exercise (assuming full vesting) will be $20,000. The company's valuation could increase fifty-fold and it wouldn't affect the cost of exercise.
Companies with skyrocketing valuations can be precarious for employees who join late, but here too employees can calculate everything up front and they should take into concern liquidity risk when evaluating what their options are really worth.
- scurvy 11y agoYou should understand the tax (particularly AMT) implications of exercising. $20k cost to exercise. $300k to Uncle Sam (given your 50x increase).
- 7Figures2Commas 11y agoYou should understand that every situation is different. Are you talking about NSOs, or ISOs? Have you factored in the minimum tax credit? Very few articles on ISOs and AMT highlight the minimum tax credit that is applied when the amount paid under AMT exceeds what would otherwise have been paid.
- scurvy 11y agoYou still need to pay your taxes in one year to claim it as a credit in a successive year. Uncle Sam and California don't take kindly to IOU's (nor does your credit score). What if you exercise a little every year, triggering AMT each year? No credit for you and the credit is reduced the older it gets. Like you said, each situation is different, but most people are going to pay a boatload in taxes on this and not be able to claim it as a credit later on.
- tfe 11y agoSure, $20,000 for the shares but what about the taxes you'd owe on the shares? If the value increases 50-fold, does the IRS not see that as 1,000,000 - 20,000 = $980,000 of taxable income?
- rhc2104 11y agoThe cost of exercising does increase after a big jump in valuation because you have to pay AMT tax on the unrealized capital gains.
- joshjkim 11y agoIt's the AMT issue. In your example, if the company's valuation increased by 50X, the spread between the FMV and the exercise price would be $1,000,000, so you would have to pay taxes on AMT income of $980,000 - assuming AMT is 20%, that's almost $200k. It sucks =) Of course IF you are lucky enough to have $20K sitting around, enough faith in your company the day you get your options AND your company lets you early exercise, then you can avoid this. Unfortunately, for most folks those conditions are not all met =(
- nemo44x 11y agoCapital gains taxes. When the "fair market value" of the company increases away from your strike price, when you exercise your options you have to pay tax on the difference between your strike price and the fair market value. And it will be a short term capital gain so it isn't cheap. If those .20 options of your have a fair market value of 5.00 now, you will owe tax on 4.80 of capital gains. 4.80 * 100,000 is 480,000.00 and a tax rate of about 40% on that means you will owe $192,000.00 in taxes to exercises $20,000.00 in options. So you will need around $210,000.00 to get out. And even after that you're holding a non-liquid asset which could be diluted to nothing or the company could simply fail and you can't dump the stock.
- ryandrake 11y agoThen, simply don't exercise your options--you won't have any taxes to worry about.
- balls2you 11y agoSo if you don't exercise your options, then why take the pay cut and work twice as hard for a startup ? The whole thing reeks of a scam against early employees.
- ryandrake 11y agoExactly.
- sulam 11y agoAs the article states, you typically have 90 days after leaving a company to exercise your options or you lose them entirely. Yes, that avoid taxes, at the risk of eliminating any potential upside.
- ryandrake 11y agoYou have a choice though. The exercise price + taxes is the price you pay for potential upside. Not willing to take that risk? Just walk away from your options and pay nothing.
- sulam 11y agoThe article doesn't state this well, but the additional cost comes from AMT. If you exercise your options you pay AMT on the face value of a share of common stock at time of exercise minus the exercise price (the spread). This is true regardless of whether or not those options are liquid at the time. For a unicorn, the stock has most certainly increased in value over time, which means the exercise price is a fraction (possibly a very low fraction) of the current value, and you'll be writing the IRS a much larger check than you write the company. The only escape from this problem is an 83(b) election, which I've heard many companies say they don't allow (IANAL and am not sure what the circumstances are here). It's also the case that with an 83(b) election you are putting real money, potentially a significant amount of real money, into the company's bank account with no expectation of when that investment will become liquid. So this also has risks, but at least the AMT is on the spread, which is $0 in this case.
- 7Figures2Commas 11y agoVirtually nobody talks about the AMT credit when discussing ISOs and the AMT trap. Everybody assumes that AMT is this horrible beast, and while it's never a good thing, folks would do very well to have an experienced professional look at their unique situation and perform the calculations because it's often not nearly as bad as suggested.
- sulam 11y agoI have a 7 figure AMT credit that will likely never be eliminated in my lifetime. People in this position hopefully all have competent tax attorneys who understand the credit. The reality is that the credit isn't very meaningful to people like me (and I am pretty typical among people who work at Unicorns).
- mahyarm 11y agoIf you make a salary income around $150k/yr in California, your AMT credit no matter how large is going to be a few hundred dollars per year. AMT credit is worthless unless your salary income is around $300k+. AMT should not apply until you actually liquidate capital gains, but good luck getting that kind of thing passed or addressed.
- nathan_f77 11y agoThe company's valuation increases fifty-fold. Now you decide to exercise your stock options, and you pay $20,000. You have just paid $20,000 for stock that is now worth $1,000,000. The IRS now expects you to pay tax on your $980,000 in income. However, your stock is not liquid, so you can't sell it. This is why you can need "millions" to acquire your options.
- ryandrake 11y agoWhy would you exercise a stock option to receive stock you can't sell? If you can't sell it, it's not worth $1,000,000--it's a piece of paper that might one day be worth more or less than $1,000,000.
- ryan-c 11y agoBecause you'd like to do something new and if you leave you must either exercise within 90 days or lose your options.
- ryandrake 11y agoSo if you want to leave, your choices are: 1. Exercise your options, pay potentially huge taxes on it, and be left holding stock that is practically worthless because you can't sell it OR 2. Give up your options and move on with your life I know what I'd do.
- 11y ago
- s73v3r 11y agoYou're forgetting that there's much more in the cost of exercise than just the stock price. There's taxes as well. And even just thinking about the stock price, $20,000 can be a lot of money to spend on something you can't sell.