More than 90,000 workers have been laid off from privately held US tech startups in 2022. If you are one of them, how confident are you about making the right decision about your stock options?
Making the wrong decision can result in millions of dollars left on the table by not exercising. Alternatively, you can pay a lot of money out of your pocket for options that will eventually be a complete loss.
The math for making the best decision is tricky and the taxes are high, so most startup employees don’t exercise. It’s ok to wait, as long as you are at the company when it is sold or goes public.
Know Your Option Type
However, if you get laid off or quit, what do you do with your vested, unexercised options? First, determine what kind of options you have. If you have ISOs, they must be exercised within 90 days of leaving the company to maintain their special tax status. Any remaining ISOs that are not exercised after 90 days will automatically convert to NSOs and will lose their special tax status.
Next, find out the amount of time between your last day at the company and the final day that you can exercise your vested NSOs before they are terminated and returned to the company. Most companies have a post termination window of 90 days, but some can be as long as 10 years. You can find this information in your equity incentive plan document.
Ideas to Consider
Some thoughts to contemplate are:
- How far along is the company?
- How is the company performing?
- What are the chances that the company is a success?
If you think that the company won’t do well, the decision is easy. Don’t exercise your options and walk away. If you are going to exercise, how much will it cost you? Let’s go through an example.
You have 100,000 ISO options with an exercise price of $1.00 and the current 409A valuation is $10.00. You decide to exercise 10,000 ISO options (10% of your options) because the cost of exercising all 100,000 options would cost $352,000 and such a large sum of money would impair your financial plan.
For the 10,000 options, the total cost of exercise and AMT is $35,200. Then, if the company were to sell or IPO at $20.00, your option value would be worth $200,000.
Here’s a table explaining the calculations.
Exercised Options Example
Options Exercised 10,000
409A Valuation $10.00
Exercise Price $1.00
Bargain Element per Share $9.00
Bargain Element ($) $90,000
AMT at 28% $25,200
Cash Needed to Exercise $10,000
Cash Needed to Pay AMT $25,200
Total Cash Needed $35,200
Sale Price $20.00
Options 10,000
Options Proceeds $200,000
What happens to the remaining 90,000 options? That all depends on the language in your options agreement and the negotiation conversations you have with the company before you depart.
If you have a common post termination window of 90 days, chances are that the options will expire. However, if your window is longer, say 5 years, you have a lot of time to decide what to do. Remember, 91 days after leaving the company, your ISOs will convert to NSOs.
Decision Time
This is not a straightforward decision. There are many factors to consider, including but not limited to, the company’s future prospects, your current financial plan, and your tax and cash flow considerations. If you need help deciding what to do, we can have a chat.