5 things you should know before exercising your stock options
You’ve just left your job and you have unexercised stock options from the company. You don’t want to pass up on this opportunity, but you only have 90 days until your options expire, so you don’t have much time to think about it.
Now is the time to decide. And it’s ideal to consider these five things before exercising your stock options.
1. How many of your employee stock options have vested?
The first thing that you need to know about exercising your stock options when leaving your job is how many of your options have vested? Unfortunately, if you haven’t yet passed the vesting cliff, then you have to say goodbye to your employee stock options.
In most startups, the minimum vesting period is one year. If you’ve been at your job for less time than that, none of your options will have vested, so you won’t be able to exercise them. Generally, the total vesting period is four years, so if you’ve been in this job for four years or more, you’ll probably be able to exercise your entire stock options package.
The real decisions begin when you’ve passed the vesting cliff. If you’ve been in this job for between one and four years, you can exercise some but not all of your options. For example, after two years, it’s likely that 50% of your options have vested. Now you need to consider whether you’ll be able to buy enough shares to make it worth your while.
2. The cost of exercising
Examine your employee stock option plan and remind yourself about the exercise price. Multiply that price by the number of options you want to exercise to find out how much you’ll have to pay.
If you have enough funds to cover the exercise cost, that’s wonderful! But if you don’t have the money you need, all is not lost. EquityBee can help you to pay the exercise price and take advantage of your employee stock options.
3. The value of the company
When you think about the cost of exercising, cast a careful eye at the current market value of the shares you’ll be buying. Ideally, the company’s value will have increased since you were granted your stock options. To find out if that’s the case, you need to know three things about the company:
- What is the latest preferred share price?
- What is the latest common share price?
- What is the spread between your exercise price and the common share price?
The price of shares in the company depends on the company’s value. You want to be sure that the company was valued at the fair market rate by an independent appraiser. This is standard practice, but as you already know, you can’t take anything for granted.
Example:
Imagine that you have 2,000 stock options at an exercise price of $50. Since your grant date, your company’s value has doubled, so now its common share price has risen to $100. If you exercise your options now, you’ll pay $100,000 to get shares that are worth $200,000. That means the spread is $100,000 ($200,000 – $100,000 = $100,000). The value of your stock options rose, but the price you pay has stayed the same.
It’s not a guarantee that the share price will continue to grow, but it is a very encouraging sign for your company’s future success. On the other hand, if the company value dropped in the last six months, and now shares are valued at only $25 each, it would be a bad time to exercise your options. This is what it means when your options are ‘underwater.’
As well as checking the market value of your company’s shares, examine the market as a whole. Does it seem overinflated and in danger of collapsing in the near future? Is there room for growth? Think about the potential for your company’s value to rise or to fall in comparison with the rest of the market.
4. Taxes
The amount of tax you’ll have to pay when exercising your employee stock options may be significant and should be calculated carefully. Check whether your options are NSOs (non-qualified stock options) or ISOs (incentive stock options) since they carry different tax obligations upon exercise.
Your current income tax bracket is important, too. If you have NSOs, you’ll be taxed on the spread between your exercise price and the current market value of your company’s common shares, at your regular income tax rate. If you have ISOs, then you generally won’t be taxed on the spread upon exercise, but you might have to pay Alternative Minimum Tax (AMT) at the end of the tax year.
5. Exit plans
Exiting is a big event when it comes to startups. If you have good reason to think that the company is going to exit in the near future, it adds strength to your decision to exercise your stock options.
Conclusion
When you’re leaving your job, exercising your stock options can be a difficult decision at an already stressful time. Exercising your stock options can be a wise long-term investment move, as long as you are able to fund them. We can’t guarantee that you’ll make money on your employee stock options, but at least you’ll be able to make an informed decision.
