How Employees Value (Often Incorrectly) Their Stock Options

If you leave, you give up the opportunity to vest additional shares and make additional gains. Then they are yours to hold or sell Taxation In most cases options are taxed as income at the time of exercise, regardless of whether shares are sold or held. So you can use options to hedge and thereby prevent losses, but you also blunt your gains. If the answers about the stock are that it: How do unvested options work post-IPO? He has written for a variety of business publications and was awarded the Knight Foundation scholarship to Northwestern University's Medill School of Journalism. I'll punt on that process, except to mention it.

Each option contract typically represents shares of the underlying stock, so it's easy to make large gains or losses in short amounts of time. There are plenty of anecdotal stories in the online investing world of options traders making 1, or 10,percent gains in a matter of days.

Stock Prices

How do unvested options work post-IPO? Is an IPO an event that can trigger acceleration, or is this reserved for acquisition typically? Can unvested shares be canceled post-IPO? It is very unusual for an IPO to trigger acceleration. While it is easy to see an IPO as a destination for a startup, it is really the beginning of a much longer journey. An IPO means that a company is ready to have a broader base of shareholders — but it needs to continue to deliver to those shareholders, thus it needs to continue to retain its employees.

Occasionally companies will give people the option to stay for reduced option grants but that is unusual. Family businesses and business that exist outside that ecosystem of startup investors, lawyers, etc may have different arrangements. What happens if you exercise pre-IPO stock options within 90 days of quitting and the company never goes public? Then you own shares that may be hard to sell. The company may be acquired and you might grt something for your shares, or in some circumsances you can sell shares of private companies.

But the money you pay to exercise the shares is at risk. This entire article and your answer to my question has been the best write up on this topic that I could find on the Internet. I received the agreement, signed it, and got a copy of it back signed by the corporate secretary. I never received any other documentation since.

Should I contact HR or a financial advisor? Just slightly concerned since the company seems a little secretive to me. I have been with them for over 6 years. Usually you have 90 days after leaving until you have to exercise the options, but this varies from plan to plan and the details should be in the paperwork you signed. One data point that you will need to finalize your decision is the FMV fair market value of the shares for tax purposes.

The company should be willing to tell you this; if it is quite a bit more than a penny some taxes will be due on exercise but the shares are more likely to be worth something. Thanks Max, I really appreciate it. After reading your article and doing some research I found out I was looking at the par value, not the exercise price. So in my case, I would be severely underwater. Thanks again for sharing your knowledge!

Max, thanks for the great info. I am considering joining a tech startup and wonder if there are enough benefits for both the company and myself for me to be brought on as an independent contractor vs. Any info you have or can refer me to would be helpful.

Sorry for the delay. But even then, you will probably not get benefits or stock options. Good luck with your decision. The terms of preferred stock vary, not only from company to company but also across different series of preferred stock in a company. I may not have time to answer but feel free to try me first initial last name at gmail. Hi Max — thanks for the insightful article. Half of my stock options have vested.

I got them at a price of 3 and the current valuation is now at 4. Do I get to leave with my vested as of departure date options or do I need to pay the company to buy them at the granted strike PLUS pay the tax on the gains etc.

Putting aside any idiosyncrasies of your specific options agreement, typically you have 90 days after departure to exercise. So within that 90 days you need to pay the strike price and you incur a tax liability. Keep in mind the stock could decline before you can sell, so its not just acash flow exposure, you may wind up selling for less than you paid to exercise. Thanks for the help! Question — I purchased stock and then my company got purchased.

My understanding is that the main investors lost money on their sale they sold below what they put into the company. Do you have any experience with seeing employees receive additional option grants with promotions?

Is this common or only at key-level positions? I joined the sales team of a person startup at an entry level position about 2 years ago. Is it reasonable to ask? It is common but not universal to receive additional grants with significant promotions, but there is wide variety in how these are handled: I would ask your employer what the process is to ensure that your stock is commensurate with your current contribution to the company.

For example, if when you joined an entry level employee received shares and an account exec received , but today an entry level employee receives shares and an account exec receives If this is the case, many companies would not give you additional shares to go with the promotion but would increase your salary. While this example may sound exaggerated, if the company has twice as many employees, grants may be half the size per employee — often the board will think about how much stock should go to all employees as a whole per year, and now there are twice as many to share the same number of shares.

In any case whatever that value is, is it fair compensation for your time? How long do you have to stay to vest the options? And how much work are you expected to do? How does your stake compare to other participants and their contribution? I need your help! My company is a Green Sustainable clothes recycling company.. I think 4 years is most common, maybe 5 next most, years is unusual.

I am not sure what else you are asking. If you are asking about taxes on the equity, if it is options there is typically no tax on vesting if the plan is set up properly which will almost certainly require an attorney. How often should a company revalue their privatly held stock options?

Any guidelines around that in the accounting standards? I am not a tax lawyer but I think for tax purposes the valuations are good for a year. If things change eg, financing, offer to buy the company, or other significant events you may want to do it more frequently, and for rapidly growing companies that might go public soon you may want to do it more frequently.

With startups becoming a global tendency, it becomes complicated to create one model that fits all. Any thoughts on adjusting vesting schedules, cliff periods and accelerations to ventures occurring in high-risk geographical areas? One thing that I do see adjusted globally is some of the details to fit local tax laws — even US-based companies have to administer their plans differently in different jurisdictions.

Maybe a reader knows?? Great article, now for my question. Been working for a company 3 years, been vested, for example, , shares, at 5 cents a share. Leaving company, It looks like the period to exerci se, buying the shares will have about 7 more years. When I leave, how long does one usually, have to buy the shares, if they choose.

I am a little confused about the 90days mentioned ealier in the article. Usually the option period is 10 years but only while you are employed. When you leave, the unvestef options go away and you have 90 days to exercise the vested options. Of course it depends on your specific option plan which may be completely different.

I have some vested preferred shares. What are my options to liquidate them before any event? Your option may be to find someone who wants to buy the stock in a private transaction with limited data. Or it may be that the company has to give permission even if you find a buyer. Trading private stock is difficult. Also if you have options, typically you will have to exercise them before you can sell them.

These stock options shall be deemed to have been granted January 31, and shall have a term of 3 years from the effective date granted. These stock options shall remain vested for a period of 24 months in which Employee remains in his current position with the Company. It sounds like you have between 2 and 3 years in which to exercise them. The vesting language is a bit unclear to me.

You may want to get some legal advice, I cannot interpret that clearly. Let me elaborate on this as I am in the middle of an asset acquisition a division of the company is being bought that will close on Jan 31, I am still trying to understand the language above and below and what my options will be once the transaction is complete. The strike price above given seems a bit high.

How does this work in terms of an asset being acquired as opposed to the entire company? As Twitter is going public soon and I am in the last round of interview.

If they offer me a job, will there be any impact to my equity offering if I join before they go IPO or will it be the same after they go IPO? Which will be most beneficiary to me?

Typically people expect the price to increase on I and thus try to get in prior. Predicting what actually happens is hard,for example Facebook went down. But generally joining before IPO is viewed as a better bet. On the day of my 7hrs in person interview conclusion, HR mentioned that they are not the highest paid company around, they come in like 60th percentile… But their RSU are at great offer.

I have been offered just over shares for. Our company is expecting to be acquired in the next 90 days so I could end up with no vested options… What happens if we get acquired before I am vested?

The other thing that complicates it is that our company has a few different products we offer and the one that is getting acquired is the one I work on.. Does this make sense? Typically if the acquiring company does not want to keep you they can terminate you and your unvested options will not vest. If they want to keep you they would typically exchange your options for options in the new company.

They will have some discretion in how to do this. Hopefully they will want to keep you and will treat you well.

Now after 6 months the company is acquired by another company for cash buyout. Since I exercised my stock options just 4 months ago, will I be not considered for Long term Capital gain taxes? Or can I hold on to my share certificates for 9 more months and then will I eligible for Long term capital gain tax rate? Check with an attorney to be sure, it could depend on the details of that specific transaction but usually they close faster than that.

We received an initial payout and had a subsequent release of the escrow amount withheld. This escrow payout was received over 1 year after the sale of the company. What is this payout considered? Is it a long term capital gains? Also, what about a milestone payout that falls under similar circumstance? I am not a tax attorney so I am not sure. If it came through regular payroll as a bonus my guess is that it is not long term capital gains.

Hi Max — Great article! I have a question. I joined a company as one of the first 3 sales directors hired and was told in my offer letter I have , stock options pending board approval. I have now been working for the company for 18 months and have not received any documentation regarding my options. I am continually told that they will be approved at the next board meeting but that has not happened and I was recently told they would be approved after the next round of funding but that did not happen either.

What is happening here and what is your recommendation? Thank you in advance for your assistance. Something is not right. Sometimes the approval will be left out of a board meeting.

With really bad luck you could be skipped twice. There is no good explanation for 18 months. But something is wrong with your company and I would be looking hard for something new. Sorry to be the bearer of bad news. If the CEO has an explanation that really makes sense feel free to share it and I will let you know what I think, maybe I have missed an innocent explanation but this does not sound right. You always get the most money, both grants and salary, by moving.

Plus once you leave, you have an even less useful view of the company. Great post… with a lot to think about. However, as Jim Wang in the comments and you in the article point out, your judgement of the company may be clouded by having worked there. Also, pre-IPO startups these days perform reverse-splits and a lot of other accounting techniques to get more value to the VCs and investment bankers and away from the common employee option holders, so you still may make a return, but baggers are pretty rare anymore.

You hit on a really good point that established companies are more lucrative than startups. At that point, the company is still giving out options to new hires, and you have a few years to decide how the company is doing before you have to make a decision on whether you want to exercise your options or not and you usually can do a same-day sale because the company is public. Interesting viewpoint on the best time to join a company is after the IPO.

Hopefully the company is paying close to market salaries by then. But experience I had was that once my company when IPO, there was a lot of managers who started to slack off, and there was a lot of dissension among those who struck it rich and the relatively new were people who still had to put in their dues.

Compared to that, the relatively small amount of money it will cost you to see what happens is worth the wild ride. Good point about the strick prices on options being discounted to the recent valuation anyway, and there could be more discount for employees. Exiting is the big X factor.

Personally, I think it comes down to trust. How much do your trust your own ability to accurately evaluate the potential of your company when you leave? How much do you trust that company to treat private investors like you? Some companies operate honorably. Some companies are known to bend every rule to the breaking point to avoid giving anyone any money at all, ever. As an inconsequential investor in a private company, you have almost no insight into the company, and little practical recourse, should they decide to cheat you.

But hopefully, as an employee of the private company, you have great insight into the numbers. It really depends on how much I believe in the company and how much liquidity I have. I can see it from your perspective as a contractor, though. Diversifying by individually picking stocks is still close to gambling at the end of the day, so I agree with you: RSUs are a different matter, you have no choice but to take them. I blogged here on why RSUs need to be sold as soon as you get them:.

I left a start-up after working there for 5 years. At the time of my leaving I knew the company needed to pivot and re-structure. He would probably kick yourself if the company is doing well and the turned into 30, For every dollar of private shares purchased, an equivalent value of options was issued with 3-year terms. The first set of options expire next August, then some in September, and more in July We expect that by then, there will be some serious progress on revenue growth the company makes a product due to some major new distribution channels that are opening up.

It is very possible that the value of the options will well-exceed the purchase price by the time they expire, which will make the choice pretty easy.

If all goes well the company could have huge growth and would be a likely acquisition target at many times the current valuation. I should clarify, I have stock warrants not options. So, a great deal as it turned out. A good problem to have! As this article rightly notes, even if the options pay off in the money there is little chance it will make up for the lower salary. Most often, Richards said, you'll see a 1X liquidation preference — which means that in the event of liquidation, like if the company is sold, those shareholders are paid back at least the same amount they invested.

This can spell problems for employees if the company doesn't ever reach its expected potential value, because the founders are still obligated to pay back the liquidation preference to preferred shareholders.

Although there are a variety of ways to get equity as a startup employee, the most common way is through stock options. A stock option is the guarantee of an employee to be able to purchase a set amount of stock at a set price regardless of future increases in value. The price at which the shares are offered is referred to as the "strike price," and when you purchase the shares at that price, you are "exercising" your options.

Exercising stock options is a fairly common transaction, but Y Combinator partner Aaron Harris said there are some additional rules among startups that could present problems.

While there are arguments in favor of that rule, Harris said it penalizes younger employees who don't have the capital to exercise options and deal with the tax hit at the time. Outside of stock options, Richards said that a growing trend is the issuing of restricted stock units RSU.

These stock units are generally awarded directly to the employee with no purchase required. But, they carry different tax implications, which I will address later on. Shares in a startup are different from shares in a public company because they are not fully "vested. You'll see this often referred to sometimes as a vesting schedule. For example, if you are granted 1, shares at four-year vesting, you would receive shares at the end of each of the four years until it was fully vested.

Richards said that a four-year vesting period is pretty standard. In addition to a vesting schedule, you'll also be dealing with a cliff, or the probationary time before the vesting will begin. A traditional cliff is six months to one year. You will not vest any shares before you hit the cliff, but all of the shares for that time will vest when you do hit the cliff. For example, if you have a six month cliff, you will not vest any equity in the first six months of your employment, but at the six month mark, you will have vested six months worth of your vesting schedule.

After that, your shares will continue to vest per month. The implementation of a vesting schedule and a cliff are both done to keep talent from leaving the company too soon. When you're granted equity by a startup, it may be taxable. The type of equity you receive, and whether or not you paid for it play into the question, Graffagnini said. Brock said that ISO do not create a taxable event until they are sold. So, when you exercise an ISO no income is reported. But, when you sell it after exercising, it is taxed as long-term capital gains.

TO BUY OR NOT TO BUY YOUR OPTIONS

In general, the value of a stock option to a risk-averse employee can be substantially below the firm’s cost of granting the stock option. Thus, the value of a stock option to an employee should not exceed the Black-Scholes value of the option. Future value of your employee stock options. The future value of your employee stock options will depend on two factors: the performance of the underlying stock and the strike price of your options. For example, if the stock is worth $30 and your option's strike price is $25, your options will be worth $5 per share. The better strategy with stock options. Stock options are an excellent benefit — if there is no cost to the employee in the form of reduced salary or benefits. In that situation, the employee will win if the stock price rises above the .