Berkeley CSUA MOTD:Entry 53840
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2017/10/23 [General] UID:1000 Activity:popular
10/23   

2010/5/19-6/30 [Industry/Startup] UID:53840 Activity:nil
5/19    I'm working for an early stage startup, and they want to grant me
        stock options.  However, they are claiming that I must either pay
        tens of thousands of dollars to purchase the options at the
        current valuation, or have it be taken as personal income when I
        (eventually) try to cash out.  It seems that both of these
        are terrible choices.  Are there any other ways to deal with
        this sort of situation?  I'd like the capital gains but feel
        that I shouldn't be paying nearly half my after-tax income
        just to purchase the stock that should be an incentive, not
        a liability.
        \ _ Your employers are retards.  leave.
        \_ It sounds like this is either your first experience with stock
           options or your first experience at a startup.  If this is an
           early stage startup and the purchase price and valuation of an
           option are equal, then exercising them is a very, very risky
           thing to do.  Most startups fail.  You can realize no value for
           your options until the shares can be sold (you're not publically
           traded yet -- who are you going to sell your shares to and how
           will you and the buyer determine the value?).  The whole point of
           an option is that you can, at a later date, buy shares for what
           they were worth long ago when you started working there (assuming
           the place succeeds).  It sounds like you are years away from
           needing to worry about this.  You also need to learn about
           Alternative Minimum Tax (AMT) and how it relates to stock options.
           If the place takes off and the options become worth something,
           seek professional help for a good financial advisor.
           seek professional help from a good financial advisor.
        \_ Read this:
           http://www.fairmark.com/execcomp/nqotime.htm
           \_ This is excellent.  I made about $20,000 on my options using the
              "exercise and sell" option (or cashless sell) as in this article.
              Note that you need to know whether they are NQO or ISO options to
              properly follow this advice, because the tax ramifications are
              different.  For NQOs this article is right on the money.
              \_ That article is moronic.   Who the hell would exercise an
                 option to buy  a share at $10, when the share price *IS*
                 $10?  This was helpful to you?!?  Next he is going to follow
                 it up with a brilliant and insightful article explaining how
                 if you have an option to buy a $10 stock at $11, it is a sub-
                 optimal strategy to exercise and sell.
        \_ The "either ... or ..." that your employer said are usually both
           true for late startups.  For early startups, the current valuation
           at the time of option granting is usually very low.  When I joined
           my early startup, I was granted 0.25% of the company in options, yet
           I could exercise all of it for only $200.  May be your company is
           I could exercise all of it for only $200.  Maybe your company is
           not that early of a startup.
           \_ Your company had a valuation of $80k when you started? That is
              a very early stage start-up indeed.
              \_ There were five engineers including me, and all reported to
                 the CEO.
        \_ Just shut up and pay your taxes when they are due. Also, buy Piaw's
           book.
        \_ I just left my job of 2.5 years.   I was granted a block at
           a certain price when I started, and more ( at a higher price )
           a year later.  This is a startup that has not IPO'd, and
           I think everyone involved would agree they will never IPO.
           They might get bought one day.  So I'm aware that options
           traditionally vest over 4 years.  I was not there for 4 years.
           1 week after I left, I got an email from the CEO saying that
           I could vest all of my options for a check for 17k.  No mention
           of current prices, estimated company valuation, number of
           options already out there, nothing.  From some numbers thrown
           around at me from the old CFO who got fired 2 years ago, I
           estimate I was given options for a little less than .10% of the
           company.  I think the CEO is just trying to get more money for
           his company, but I really can't tell.
2017/10/23 [General] UID:1000 Activity:popular
10/23   

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www.fairmark.com/execcomp/nqotime.htm
Kaye A Thomas Should you exercise a nonqualified stock option before you're ready to sell the stock? What's the best time to exercise a nonqualified stock option? Or should you exercise earlier and hold the stock for at least a year and a day, so that part of your gain is taxed as long-term capital gain? The setup Let's consider three different guys: Able, Baker and Charlie. All three have worked for a publicly held company for several years, and each received a nonqualified option to buy 1,000 shares of stock at $10 per share. The market price of the stock was $10 per share when they received their options, but rose all the way to $110 per share before they finally cashed out. Able's strategy was to hold onto the option until he was ready to cash out. When the stock reached $110, he exercised the option and sold the stock immediately. His profit was $100,000, all taxed as compensation income at roughly 40%. He paid $40,000 in income tax and ended up with $60,000. Baker's strategy was to hold the option for a while but then exercise and hold the stock while it went up some more. He exercised when the stock was at $60, then held the stock for more than a year until it reached $110. This strategy allowed him to report some of his profit as long-term capital gain, paying a tax rate of only 20% on that part of his profit. He exercised the option right away, while the stock was trading in the market at $10. He held for more than a year and sold when the stock reached $110. His entire profit of $100,000 was taxed as long-term capital gain, so he paid only $20,000 and ended up with $80,000. Charlie came out the best in terms of dollars in his pocket, but actually used a very foolish strategy. At the time he used $10,000 to exercise his option, he could have used $10,000 to buy stock in the open market. If he did this, he would have taken exactly the same risk, and had exactly the same result, with one difference: he still would have owned the option. When the stock reached $110, he could have sold the stock he bought in the market (putting $80,000 in his pocket, after tax) and cashed in the option like Able did putting another $60,000 in his pocket. Charlie's strategy produced what looks like a good result, but in reality he simply threw away the value of his option for no reason. At the time he exercised his option to buy at $10, the stock was trading at $60, so he couldn't have bought the stock in the market just as cheaply. But Baker had to come up with some money at the time he exercised the option: $10,000 to pay the exercise price, and another $20,000 to pay the tax on his $50,000 of profit at that point. The total value of his option stock was $60,000 at that point, and he had to come up with $30,000, or half of that amount. If Baker had to sell stock to come up with the $30,000, then he had only half as much stock during the second half of the ride, as the stock went up from $60 to $110. That portion of his profit was only $25,000, because he held half as much stock. He pays only $5,000 in capital gain tax when he finally cashes out, but overall he ends up with just $50,000. That's better than a sharp stick in the eye, but not nearly as good as Able's $60,000. Even if Baker has $30,000 lying around to pay the exercise price and the tax without selling the stock, the strategy of exercising and holding the stock isn't likely to make sense. He loses the investment return on that $30,000 during the time he has to wait until the stock reaches $110. If he sincerely believes the stock is going to $110, he's better off using the $30,000 to buy more shares in the market instead of using that money to exercise the option. Limitations These comments apply to situations where the option holder has freedom of choice that isn't always available. In other situations the strategies of Baker and Charlie may turn out to make good sense. It may make sense to follow Charlie's approach of exercising the option before the stock has gone up in value, so that all your profit will be taxed as long-term capital gain. There's risk in this approach, of course, but the payoff can be substantial, as Charlie's numbers show. For example, your employment may terminate at a time when you're convinced the stock is going to take off. Normally you have to exercise an option or forfeit it when employment terminates, and in this situation it may make sense to do as Baker did: exercise the option and hold the stock. The thing that is most surprising, though, is that in the situation where the option holder has complete freedom of choice, the strategy that works best is generally the one that results in paying the most tax! That doesn't seem possible, but the logic is inescapable.