Should You Exercise Your Stock Options After Leaving a Startup?

You left your job and you are now focused on your next challenge. Getting ready for the first day on the new job and you suddenly get an email from your previous employer. The subject line reads: “Your options are about to expire”. You open the email and realize you only have a few weeks, or even days, until your options are gone. So should you exercise your stock options after leaving a startup?

It’s decision time.

To exercise, or not to exercise? That is the question.

What is a Post-Termination Exercise Period?

A post termination exercise period, or PTE, is the time frame employers give their employees to exercise their stock options post-termination, voluntary or not. That window is typically 30-90 days long, which means you only get a few weeks to decide whether or not you want to exercise your options, and to actually get the money to do so. If you don’t exercise the options by the end of this period, you lose them and they are essentially returned to the company.

Should I exercise my stock options after leaving a startup or just let them expire?

The exercise-or-not to exercise question is really an investment decision. The cost can be substantial – it could eat up a sizable chunk of your savings, or you may not even have enough money saved up at all – so it’s not necessarily an easy decision to make.

In this post we will try to lay out a logic that can help you make the decision that’s right for you.

Let’s start by eliminating a few common elements that should not affect your decision but do end up affecting most people. Surprise surprise, they’re emotional.

I spent the last few years working hard for these options and now I’ll just let them expire?

Ugh, emotions. Always trying to interfere with your logic. It’s hard to ignore these emotions – we get it. You feel like you’ve earned something and now it’ll all go to waste. But don’t forget that exercising your options is not free – so the fact that you’ve spent time working for the company should not make a difference – that’s a sunk cost[1]. You should be looking forward and not backwards. Does the investment make sense now? That’s all you should care about.

What if the company goes public and I’ll miss out?

Another emotion that may hit you is FOMO (fear of missing out) – what if the company goes public and all my former-colleagues become millionaires and I don’t. Will I be invited to their pool parties? Try to put that aside and analyze this decision as an investment decision that has nothing to do with your time at the company and your soon-to-maybe-become-millionaire friends.

We know it’s not easy, but you have to try real hard.

I have an opportunity to invest now that I won’t have again.

Scarcity is known as one of the strongest tools and methods sales people use for persuasion. It’s simple – when a product is limited in availability, it becomes more attractive. Psychologists have proven this time and time again – scarcity affects our decision making.

Start by recognizing that scarcity may affect your decision and then try to eliminate it. Like FOMO, scarcity should not impact your investment decision.

Now that we have (hopefully) eliminated these emotional factors, time to move on.

As someone who knows the company from within, the first and most important question you should ask yourself is: Do I believe in the company? Do I believe in their value proposition? Do I believe in their product? Their management? Their ability to execute? Given everything I know about the company, the market, the competition, etc., do I think this company has a chance of being acquired or going public?

If the answers are primarily positive, you should consider investing.

The next question is How Much Should I Invest?

While the first question of whether or not to invest focuses on the company’s health and situation, the question of how much to invest should be more focused on you. This is a personal decision that has more to do with your financial situation and individual preferences.

There’s no right or wrong here, but here are a few useful exercises to go through when making this decision.

How much money do you have, and are willing to potentially lose?

Let’s start with something that’s somewhat easy to figure out. How much money do you have right now? You should decide what portion of that amount you feel comfortable investing in a high-risk investment (most early-stage companies are). Try to think about this in the most extreme way – how much money are you comfortable investing knowing that you may lose it all?

What’s the opportunity cost?

Let’s move to an exercise that’s a little more advance. What would you do with the money you have in the bank, or this amount you decided to invest, if you weren’t going to exercise your options? Basically, what is the opportunity cost of this investment?

It’s not an easy exercise to go through. As Dan Ariely, one of our favorite behavioral economists, says: “Money is really about opportunity cost. Every time you buy coffee, the money comes from something else. What is this something else? We don’t envision it. With money, the tradeoffs are really unclear.” “Every time we buy something, it’s about what we are not going to be able to do in the future.” “The problem with opportunity cost is that opportunity cost is divided among many, many things.”

Two factors make this opportunity cost exercise especially challenging: the first is the difficulty of assigning value to the investment itself since you can only base that value calculation on your assumptions of how the company will do in the next few years.

The second challenge is fully envisioning the opportunity cost, since it’s long term. Companies are staying private longer, so it may very well be the case that your money will be tied up for a long time. That means that you have to envision now all the opportunities you will be giving up for the next few years and determine if the investment is worth it.

It could be another investment, a reserve for a rainy day, an extra bedroom in your next house, car repairs, money to expand the family, or for your honeymoon of your dreams.
This makes this decision a very personal one with no right or wrong answer.

How does your portfolio look?

You should determine how much risk you want to take in your portfolio, taking into account that investing in a startup is considered pretty risky. You should also consider concentration. Some investment advisers suggest limiting the exposure of one investment to 5% of your investment portfolio, while others suggest a limit of up to 30%. While that’s a pretty wide range, everybody agrees that you shouldn’t put all your eggs in one basket.

You should also think of diversification within early-stage companies. If you are changing jobs and have $10k to invest, it may make sense to use $7k to exercise options in the company you’re leaving and use the remaining $3k to invest in the company you’re joining.

What-if?

We’ve used the above exercises to try and establish lower and upper limits for your potential investment amount. Let’s say the range you got is $10k-$20k. Try to do this one last thing – ask yourself: “if I had $15k right now, independent of all other considerations, would I invest that amount in this company, knowing that I won’t have access to that money for a few years?” If the answer is no, move towards the lower end of your range and keep asking yourself the same question. If the answer is yes, keep moving up until you reach a no.

We can help!

Now that you have thought everything through and decided how much you want to invest, you shouldn’t just forego the rest of your options. EquityBee is here to help you enjoy the potential future upside of these options while limiting the amount that has to come out of your pocket today.

[Disclaimer: I am not a financial or investment adviser. Always consult with a professional advisor before making any investment decision.]

[1] In economics and business decision-making, a sunk cost is a cost that has already been incurred and cannot be recovered. Traditional economics proposes that economic actors should not let sunk costs influence their decisions. Doing so would not be rationally assessing a decision exclusively on its own merits.