..Employee Stock Options..

Financial Planning Tax Strategies
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…Hello…

…my son works for a California start up, and has stock options as part of his compensation…

…his first tranche has has vested, and he’s not too sure what to do…

…I never had any employee stock options, and never offered any to my employees, so I’m in the dark…

…I’ve suggested speaking with a CPA, but he’d like a better understanding of his “options” so to speak before speaking with a tax expert…

…basically, he’s got a tranche that’s vested, and he’d like to exercise them while the fair market value is closer to the strike price, as he’s worried the next round of venture capital funding will drive the fair market price significantly higher, vastly increasing his tax burden…

…if anyone knows any potential resources I can read/watch to educate myself, or questions my son should be prepared to ask once he’s located a worthy CPA, I’d appreciate it…

…I’m pretty clueless as to the mechanics of employee stock options, although regular options I’m pretty well versed…

…thanks for any help…

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…this article clarified quite a bit for me…

https://secfi.com/learn/stock-option-starter-guide

…but how do young, cash poor employees shell out the bucks to exercise their vested options?..

…do they take out loans?..

…seems crazy…

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They don’t. They hold the stock options until near expiration or they plan on leaving the company before exercising the in the money options.

Most are exercised by a sell on the same day which triggers regular income but also limits the risk of the employee to the stock losing value.

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…but how do young, cash poor employees shell out the bucks to exercise their vested options?..

…do they take out loans?..

Well for publicly traded companies, they typically do a same day sale, selling enough to pay for the offer price, plus any taxes.

But since you said …basically, he’s got a tranche that’s vested, and he’d like to exercise them while the fair market value is closer to the strike price, as he’s worried the next round of venture capital funding will drive the fair market price significantly higher, vastly increasing his tax burden… in your initial post, it would seem that your son’s company isn’t publicly traded, so that’s probably not an option.

In that case, I would strongly suggest that he fully understand what both his tax obligation and the funds that will be required to exercise the options - which could be different, depending on what type of options he was granted and the company’s plan rules. His HR department would be the starting point to gain that understanding.

AJ

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As AJ said getting the rules is a great starting point. Another good point to check is you tax preparer. That person hopefully has a few years of experience with the option holder and will know the important questions to ask about both trends in spending and income. In our experience there almost always are things beyond just one item that impact taxes. Surprises in this area are generally not good.

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…do they take out loans?..

And apparently, some start-up employees do take out loans, ‘generously’ provided by their employers, and then get burned when the start-up downsizes (or they leave for some other reason) https://www.wired.com/story/bolt-stock-loans/

You probably want to warn your son against taking out such a loan unless he has another plan on how to pay it back.

AJ

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in your initial post, it would seem that your son’s company isn’t publicly traded, so that’s probably not an option.

In that case, I would strongly suggest that he fully understand what both his tax obligation and the funds that will be required to exercise the options - which could be different, depending on what type of options he was granted and the company’s plan rules. His HR department would be the starting point to gain that understanding.

…my apologies for not mentioning originally…

…yes, very small start up (son was 13th employee, and they’re up to ~30 or so)…

…I don’t believe they have an “HR Department” officially, but someone must be acting as one…son has been doing his own interviews for his expanding department…

…I’m guessing, but I’d imagine these are NSO’s…

…say he has 1000 NSO’s vested at a 2 dollar strike, with a fair market value of 3…(if exercised he’d pay income tax on a dollar)…

…but his fear is the FMV will jump significantly once the next round of VC is funded…some suggest the FMV may jump to 20, or 30…(why, I dunno)…

…wouldn’t one want to exercise as early as possible, minimizing taxes today and assume the risk of stock ownership, as opposed to holding the vested options and getting potentially slammed by taxes later if the FMV actually does jump by an order of magnitude or more?..

…I understand that ”the taxman cometh” regardless, as the cost basis would be higher if he waited, but I’ve always liked keeping your taxes low now, as we never know what’s coming in the future…

…anyway, I appreciate all the responses, and again, my apologies for learning on the fly…

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…but his fear is the FMV will jump significantly once the next round of VC is funded…some suggest the FMV may jump to 20, or 30…(why, I dunno)…

Given that credit is tightening significantly, tech stocks are down significantly and the number of IPOs has decreased significantly YOY (which can be leading indicators of decreases in VC funding), if I were your son, I’d probably be more worried about the company just getting the next round of funding so that they can continue operating.

But maybe that’s because I’ve seen what can happen when VC funding is required to maintain operations: Back in 2008, Joel was working for a start-up that had a working product but hadn’t gotten it to market yet. The CEO was negotiating with VCs for what was expected to be the last round of funding, and apparently didn’t think that the VC offer was valuing the company at a high enough value, so he passed on the offer, thinking he could get a better one - just as all the VC funding was drying up. It was a bad mistake. The company shut down a couple of months later, and Joel, along with everyone else, was laid off, without even COBRA, because the company was no longer a going concern, and therefore, the policy lapsed.

I will say that there is speculation that VC funding is going to dry up in 2022 https://files.pitchbook.com/website/files/pdf/Q1_2022_VC_Qua…

AJ

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…say he has 1000 NSO’s vested at a 2 dollar strike, with a fair market value of 3…(if exercised he’d pay income tax on a dollar)…

If he exercised and sold, he’d pay income tax on a dollar.

If he exercised and kept, he might pay income tax on the 2 dollar strike price value. Be careful, the type option matters. Stock options are complicated.

The fair market value can result in AMT.

For some types of employee stock options, part of the transaction can be reported as W-2 income. Many tax professionals who aren’t familiar with stock options can miss this part of the cost basis.

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You probably want to warn your son against taking out such a loan unless he has another plan on how to pay it back.

Now that’s a novel idea. Kids paying back loans. I thought these days loans were forgiven.

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Now that’s a novel idea. Kids paying back loans.

I would point out that these particular loans may be given to any employee, no matter how young or old they are. So it’s not just ‘kids’ who would need to pay back a loan.

I thought these days loans were forgiven.

Well, if you had read the article about employees taking out loans that I posted, you would have seen that when a companies fail, these loans are sometimes forgiven. However, then the IRS comes calling, because the forgiven loan becomes income, and the former employee owes taxes on the income.

AJ

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Well, if you had read the article …

Please forgive me AJ. Mea Culpa, Mea Culpa, Mea Maxima Culpa.

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