Author Topic: Getting a line of credit or a loan for startup stock options  (Read 7304 times)

optionsguy

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Getting a line of credit or a loan for startup stock options
« on: January 26, 2015, 12:11:52 AM »
Hey all, first post. I have a very high quality problem in front of me and would love your advice. Here's the background:

  • I work at a startup and have vested stock options
  • The fair market value of these options has recently gone up substantially relative to my strike price (~13x)
  • I've exercised everything that was vested up to this point (prior to the jump up 13x), and have my AMT taken care of
  • As the year progresses, I plan on continuing to exercise my options, but since the FMV is so high, the tax bill is ~3x the exercise cost

I'm considering taking out a 50k - 100k line of credit or a loan in order to exercise options throughout this year, and pay my quarterly estimate tax bill. Annual income is ~130k. My reasoning is that I think the FMV will continue to go up, and if I leave the company before a liquidity event (which I think I will), I only have 90 days to purchase any remaining vested options. If the FMV is dramatically higher relative to where it is today, I owe even more to Uncle Sam. I'm essentially trying to mitigate golden handcuffs as best I can. Cry you a river, right?

Outside of all the downside risk and general market unpredictability of exercising this many options, I have a few questions for you wonderful people:

  • Is taking out a line of credit to pay estimated quarterly taxes dumb?
  • What's the best way to do this? Credit Union? Regular Bank? Prosper / LendingClub?
  • Are there any companies that specialize in this kind of thing?
  • Should I put the already exercised equity up as collateral?
  • What's the best way to drive the APR down as much as possible for something like this?
  • Anything else I'm missing? Anything else I should think about?

I was shocked that I wasn't able Google around for this answer, so here I am posing the question.

What do you think? Would love your thoughts!

optionsguy

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Re: Getting a line of credit or a loan for startup stock options
« Reply #1 on: January 26, 2015, 12:31:53 AM »
Thanks for the reply, Cathy!

Interesting. So I have ~60k in an IRA with Vanguard. Would I be able to use that as a pledged asset line product? Do you think I could get ~100k with those assets? Does Vanguard offer a product like that?

jmusic

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Re: Getting a line of credit or a loan for startup stock options
« Reply #2 on: January 26, 2015, 12:39:56 AM »
Out of curiosity, why not sell some stock immediately after exercising to pay the tax bill? 

I know exercising options is a taxable event even though you don't technically "earn" the related income, but then your basis should step up to the exercise price, at which point you should be able to turn around and sell (some of) the stock.  ST/LT capital gains rates would depend on how long you've held the options, not the stock...

MDM

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Re: Getting a line of credit or a loan for startup stock options
« Reply #3 on: January 26, 2015, 12:42:50 AM »
Do you have to pay estimated taxes?

If have as much withheld in 2015 as you paid taxes in 2014 (or 110% of that amount if your total earnings are high enough), then you avoid any penalties.  You'll still need to pay the tax bill come April 2016, but not until then.  Don't know if that timing matters....

See http://forum.mrmoneymustache.com/ask-a-mustachian/exemption-from-federal-withholding-on-w4/ for more discussion.  That thread isn't completely on point for your situation but close enough.

MDM

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Re: Getting a line of credit or a loan for startup stock options
« Reply #4 on: January 26, 2015, 12:52:45 AM »
ST/LT capital gains rates would depend on how long you've held the options, not the stock...
That may be true for some option types (which were you thinking of?), but not all.  Personal experience has been that the capital gains type clock started ticking the day the options were exercised and the stock acquired.

Goldielocks

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Re: Getting a line of credit or a loan for startup stock options
« Reply #5 on: January 26, 2015, 01:39:34 AM »
Hey all, first post. I have a very high quality problem in front of me and would love your advice. Here's the background:

  • I work at a startup and have vested stock options
  • The fair market value of these options has recently gone up substantially relative to my strike price (~13x)
  • I've exercised everything that was vested up to this point (prior to the jump up 13x), and have my AMT taken care of
  • As the year progresses, I plan on continuing to exercise my options, but since the FMV is so high, the tax bill is ~3x the exercise cost

I'm considering taking out a 50k - 100k line of credit or a loan in order to exercise options throughout this year, and pay my quarterly estimate tax bill. Annual income is ~130k. My reasoning is that I think the FMV will continue to go up, and if I leave the company before a liquidity event (which I think I will), I only have 90 days to purchase any remaining vested options. If the FMV is dramatically higher relative to where it is today, I owe even more to Uncle Sam. I'm essentially trying to mitigate golden handcuffs as best I can. Cry you a river, right?

Outside of all the downside risk and general market unpredictability of exercising this many options, I have a few questions for you wonderful people:

  • Is taking out a line of credit to pay estimated quarterly taxes dumb?
  • What's the best way to do this? Credit Union? Regular Bank? Prosper / LendingClub?
  • Are there any companies that specialize in this kind of thing?
  • Should I put the already exercised equity up as collateral?
  • What's the best way to drive the APR down as much as possible for something like this?
  • Anything else I'm missing? Anything else I should think about?

I was shocked that I wasn't able Google around for this answer, so here I am posing the question.

What do you think? Would love your thoughts!

Just sell the shares to pay the taxes. 
We were there, and held on, and watched the shares drop from around $40/share to less than $2 per share in about 3 days.  Startups are a nightmare.   Especially when the financers are trying to short sell or pump money (profits) from the company and then a rumor starts a wildfire in the investors.

We thought a senior person was crazy to sell at only $30k profit, (she was able to get hers vested a little ahead of the big upsweep), and we had over $80k in share value at one time, (through options, not our own $$'s directly) and ended up owing $5k on taxes (net loss).

Exercise and sell and pay your taxes and gloat over the money, and count yourself lucky..

clifp

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Re: Getting a line of credit or a loan for startup stock options
« Reply #6 on: January 26, 2015, 04:03:37 AM »
Several questions for the OP.  From your description it sounds like these options are incentive stock options (ISO) and not Non Qualified options.  If they are non qualified I certainly wouldn't bother with any of this hassle.

All I am sure Cathy is right for her company, still I'd say most case, especially start ups, you can you the either your current stock, or the shares you just exercised as collateral.  However, since they aren't publicly traded it isn't something that you average brokerage firm will be able to deal with.  I know Schwab has alternative investment department, and I think Fidelity may have one also, but more than likely you will have to find a firm that specializing in this. I know they are out there I just don't have any names for you..

Second on most importantly how confident are you that there will be a liquidity event in the future?  There are lot of things that can go wrong in the life of startup before the the actually liquidity.  I know in my 2nd company out college I exercised the options as soon as good only to be left holding worthless when the company went under.  The nightmare scenario is to have to pay AMT on worthless stock. What Series of financing are the currently on A, B, C...

Finally, are you sure you tax saving are going to be the dramatic?  Since it sounds like you are  subject to AMT due exercising ISO options, your AMT rate is 26% (quite about above the LT Cap gains rate), your current bracket is 28% and but if you end up waiting to exercise until there is actually a liquidity event worse case you'll be in the 33% bracket, higher than the 26% AMT bracket, but is really worth hassle and more importantly the risk for 7%.?

My advice would be go take  the CFO and/or treasurer to lunch, find out what he is doing and more than likely copy him.  The finance guy tend to have pretty realistic assessment of what's going with a startup.

chasesfish

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Re: Getting a line of credit or a loan for startup stock options
« Reply #7 on: January 26, 2015, 05:13:03 AM »
Cathy - you're expertise in this is excellent, I only have experience with this in a publicly traded company and the stock clearinghouse is more than happy to do a cashless transaction for a fee.

Doesn't the question to the original poster come down to how confident is he/she that these options will at least hold their value, if not be worth significantly more in the future?  They're basically purchasing these at a 50-70% discount (cost + tax bite on the gain).  It seems highly profitable if it works out, but could leave that person holding the bag if it doesn't.


optionsguy

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Re: Getting a line of credit or a loan for startup stock options
« Reply #8 on: January 26, 2015, 09:58:00 PM »
Wow! Thank you all so much for your replies!

  • The company is not public. I can't sell the stock anytime soon.
  • The reason why I'm looking to exercise all these options before new fair market value numbers come out is because I'm trying to prevent owing even more if I leave before a liquidity event (read: IPO)
  • @Cathy - thanks for that re: the IRA - I had no idea that putting it up for collateral is like taking a distribution
  • @Cathy - didn't even think of that. You're right - I doubt I'm allowed to put that up as collateral

Two questions:

- The 60k in my retirement is mixed between a company 401k, a roth IRA and a SEP IRA - does that change anything?
- Any other recommendations on how I can get a credit line, and where I should go? My on-paper net worth is ~500k and I have great credit so it seems ridiculous that I would have an 18% APR, but that's what all the APR calculators are saying for an unsecured loan or line of credit

optionsguy

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Re: Getting a line of credit or a loan for startup stock options
« Reply #9 on: January 26, 2015, 10:52:44 PM »
That's scary, but maybe I'll look into it. Do all credit cards have a cash credit line, or does it depend?

I have a credit card with a 35k credit line at 7% - that actually doesn't seem that bad relative to these other options.

optionsguy

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Re: Getting a line of credit or a loan for startup stock options
« Reply #10 on: January 26, 2015, 11:03:38 PM »
Sorry, I meant on one card I have a 50k limit, 35k is the cash limit. I can't seem to find it on my other ones.

Is there a way to search for cards on nerd wallet or bank rate for cards based on their cash credit line? Is that a thing? I'm trying to look now but it doesn't seem to be a filter anywhere. Is this all just super risky?

chasesfish

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Re: Getting a line of credit or a loan for startup stock options
« Reply #11 on: January 27, 2015, 06:17:09 AM »
I have a question here as the banker in the room:  Why do this on a line of credit?

Go get an unsecured term loan from someone like Lending Club and repay it over 3-5 years.  You have the income to support that.

Ccube19

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Re: Getting a line of credit or a loan for startup stock options
« Reply #12 on: January 27, 2015, 06:57:45 AM »
Why are you leaving the company?  I'm assuming it's something personal because most other reasons for leaving a company would shake my confidence in the IPO. Personally if I made 130k a year I'd exercise the options I can afford by spending less of my income. Taking out a loan greater then the rest of you assets for something that may turn out to be worthless seems extremely high risk.

optionsguy

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Re: Getting a line of credit or a loan for startup stock options
« Reply #13 on: January 27, 2015, 07:41:07 AM »
@Chasesfish - what are the big differences between a line of credit and an unsecured term loan? I looked at Lending Club but most of the APRs were 17%+ - any recommendation on how to drive down the APR?

@Ccube19 - I'm not leaving, I'm anticipating leaving before a liquidity event. If that happens, I'll be faced with a gargantuan, unmanageable tax bill rather than just a slightly out of reach one.

I'm not worried about the company or the IPO, and I'm saving as much as I can, but again my point is that the FMV consistently goes up every quarter. Every quarter I don't exercise, my tax liability increases substantially (this is obviously assuming the FMV continues to go up, which is definitely not guaranteed, but has gone up every quarter for awhile).

So again - not looking for advice on the riskiness of the investment - looking for options to fund the exercise.

Thanks all - what an incredibly value forum!

optionsguy

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Re: Getting a line of credit or a loan for startup stock options
« Reply #14 on: January 27, 2015, 10:43:45 PM »
I have a question here as the banker in the room:  Why do this on a line of credit?

Go get an unsecured term loan from someone like Lending Club and repay it over 3-5 years.  You have the income to support that.

I don't understand why an unsecured term loan is better than a line of credit. Any ideas why?

chasesfish

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Re: Getting a line of credit or a loan for startup stock options
« Reply #15 on: January 28, 2015, 05:59:10 AM »
The term loan has scheduled principal reductions each month, which will reduce your overall cost of interest.  Its too easy to leave the balance outstanding on the loan and I think the payments remind you that you have the debt.  You're also asking for unsecured funds, its less risky if the lender has a scheduled principal repayment monthly verses principal only due at maturity.  This should in theory equate to a lower rate. 

Have you actually applied through Lending Club?  If you have great credit and with your income, your rate should be a lot lower.  The "A" quality notes that I used to buy were in the 6-8% range, which means the borrowers were paying 8-10%.

clifp

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Re: Getting a line of credit or a loan for startup stock options
« Reply #16 on: January 28, 2015, 07:03:16 AM »
I am still puzzled why you think you tax savings are going to be so significant. Let's say you have 100K in gains today.  You exercise and owe $26,000 in AMT.  Next quarter the stock goes up another $20K  so you owe an additional 26%*20,000= $5,200.  But you are stuck with an illiquid investment that have a very difficult time selling until their is an IPO or a take over.

But eventually you are going have sell the stock and you will have to pay best case long term capital gains which is 15% and most likely case long term capital gains plus the Obamacare tax of 3.8% or effectively 19%.  It seems to me the interest cost (which is probably non deductible ) would negate much of the tax saving.

Am I missing something?

optionsguy

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Re: Getting a line of credit or a loan for startup stock options
« Reply #17 on: January 29, 2015, 07:30:00 AM »
Next quarter the stock goes up another $20K  so you owe an additional 26%*20,000= $5,200.  But you are stuck with an illiquid investment that have a very difficult time selling until their is an IPO or a take over.

Someone can correct me if I'm wrong - but I believe I only pay the AMT when I exercise. As the stock continues to move up each quarter, I'm not paying tax on it. I only pay tax when I sell again, and that AMT that I previously paid is applied as a tax credit when I liquidate.

I wouldn't be continually paying tax on the gains. I pay tax upfront on the AMT when I exercise, then I pay the difference on the gains from that moment when I sell.

clifp

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Re: Getting a line of credit or a loan for startup stock options
« Reply #18 on: January 30, 2015, 02:06:45 AM »
Next quarter the stock goes up another $20K  so you owe an additional 26%*20,000= $5,200.  But you are stuck with an illiquid investment that have a very difficult time selling until their is an IPO or a take over.

Someone can correct me if I'm wrong - but I believe I only pay the AMT when I exercise. As the stock continues to move up each quarter, I'm not paying tax on it. I only pay tax when I sell again, and that AMT that I previously paid is applied as a tax credit when I liquidate.

I wouldn't be continually paying tax on the gains. I pay tax upfront on the AMT when I exercise, then I pay the difference on the gains from that moment when I sell.

Yes you have it exactly correct you pay AMT on the difference between the exercise size price and the fair market value.  After you sell you get an AMT tax credit which can be applied to future AMT taxes, or portion (AFAIK something like $3k/year) of it can be applied ordinary income when your ordinary tax liability exceeds your AMT liability.  From personal experience I can say that I ran up 100K+ in AMT tax credits during the late 90s from exercising the stock options. I retired in 2000 and it took until 2010 to exhaust the credit, and would have been longer except for Congress passed a temporary law that made it easier to get AMT credits back.

I can also say I had one friend (and I read/heard about scores of  other horror stories) in 1999/2000 tech bubble did essentially what you are proposing. Exercised stock options in a start up prior to an IPO, paid a lot of money in AMT taxes in 1999 (which they often funded by borrowing), by the time 2000 came  the IPO never happened, cause the bubble in burst.  In my friends case the IPO happened before the bubble but as the Engineering VP he had to wait a year for the lock up period and the stock price went from $60 to $2. He then is left with a huge tax bill but the asset is basically worthless. 

In the scenario I specified where the stock goes up another 20K in the few months,  the good news about borrowing money to exercise now is you do temporarily save the 26%* 20K=$5,200. The bad news is you still have to come up with $26,000 to pay the AMT tax.  Plus you don't save the full $5,200 because when you do sell the stock you have to pay either 15% of 19% tax on the 20K long term gain. So your true tax savings are only $5,200-($3,000-$3,800)=  $1,400 to $2,200.  So in effect you are risking $26,000 in AMT tax today to save a couple thousand dollars in  a few years.

The point I was trying to make is you really want to sit down with tax planning software in hand, and see how much total taxes you save in 3-5 years, by exercising now as oppose to waiting until you have an actual liquidity event like an IPO.  Run several scenarios of liquidity events and the subsequent stock value including the case where the start up goes broke. 

I will say that interaction between how the alternative minimum tax system works and the regular tax system works is very complicated stuff.   It is quite possible worth sitting done with a CPA if we are talking about 100K plus gains.  It is also very possible the CPA has alternative suggestion. 

surfhb

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Re: Getting a line of credit or a loan for startup stock options
« Reply #19 on: January 30, 2015, 08:58:16 AM »
Not sure your entire financial situation but This scenario is exactly why people go broke and work till they are 70.   

You are taking on too much risk IMO.   

NorCal

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Re: Getting a line of credit or a loan for startup stock options
« Reply #20 on: January 30, 2015, 11:01:43 PM »
Coming from someone who has worked in finance at a startup, here are a few recommendations:

1.  Check to see if your company allows early exercise.  Most Silicon Valley companies allow you to exercise before shares vest, although they might not advertise it.  Many times the company will retain the right to repurchase the shares back from you, so do be aware of the fine print.

2.  If they allow this, and you are confident valuations will continue to climb, do an 83b election.  This will allow you to be taxed on the delta between the exercise price and the stock price on the day you exercise instead of the day your shares vest.  This will save you on taxes in the short term as long as the price keeps climbing.

3.  See if you can get permission to sell some of your shares on the private market.  This is increasingly common.  This would be your best source of funds to pay taxes from.  Your company will likely allow this if your intent is to pay taxes and purchase additional shares.  Although they might decline for a variety of reasons as well.

4.  Most importantly, ONLY EXERCISE THE VALUE OF SHARES YOU ARE WILLING TO LOSE 100% OF.  I don't care how confident you are in the future of the company.  Unless you have specific knowledge of the company's capital structure, you don't truly know what you are buying.  Startups aren't like public companies where one share equals one vote and all shares are equal.  The investors in your company hold Participating Preferred shares which have very different economics than the common stock you hold.  Investors holding 50-70% of the shares can easily walk away with 90% or even 100% of exit proceeds depending on the situation.  Even in the case of a "successful" acquisition or IPO, your shares could be worth much less than you think they are.  While there is some comfort with the current price well above the exercise price, you just don't have enough information to adequately judge the risks.

5.  Don't make ANY moves without the guidance of a CPA familiar with the nuances of ISO's.  I have a Master's in finance and significant experience with this stuff.  And the more I learn, the more I realize how important expert advice is on this topic.  ISO's aren't like investing in your standard brokerage account.  The rules are different, they can be counter-intuitive, and it's easy to walk into a massive tax bill.  Even scarier, it's very possible to pay thousands of dollars in taxes, and then have your shares turn out worthless a year later.

clifp

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Re: Getting a line of credit or a loan for startup stock options
« Reply #21 on: January 31, 2015, 02:24:04 AM »
+1 to NorCal suggestions.

optionsguy

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Re: Getting a line of credit or a loan for startup stock options
« Reply #22 on: February 01, 2015, 01:01:52 PM »
Thanks all for the advice. Last question. If we assumed:

- the company WILL IPO
- the company WILL increase in fair market value every quarter until the IPO
- I will leave before the IPO (and am forced to either buy all the options or leave them within 90 days of leaving)

Then the right move is to exercise options every quarter prior to the new fair market value evaluation, right?


clifp

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Re: Getting a line of credit or a loan for startup stock options
« Reply #23 on: February 01, 2015, 02:29:40 PM »
without knowing more details about your tax situation and in restrictions on the stock options, I couldn't give a definitive answer.

I'd say in 90%+ of the cases the short answer is Yes, you'd save money on taxes by exercising every quarter.

I'll re-emphasis again how much you'll save in taxes vs how much you risk is really the critical piece of information.
« Last Edit: February 01, 2015, 02:31:35 PM by clifp »

NorCal

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Re: Getting a line of credit or a loan for startup stock options
« Reply #24 on: February 03, 2015, 08:45:39 PM »
Thanks all for the advice. Last question. If we assumed:

- the company WILL IPO
- the company WILL increase in fair market value every quarter until the IPO
- I will leave before the IPO (and am forced to either buy all the options or leave them within 90 days of leaving)

Then the right move is to exercise options every quarter prior to the new fair market value evaluation, right?

If those are your assumptions, I would attempt to early exercise all shares (if allowed by the company) and sell existing holdings (if allowed by the company) to pay your tax bill.  Make an 83b election at the time of exercise (you have to send the form to the IRS right after exercise or you're SOL) to minimize your immediate tax bill.  And most importantly, TALK TO A TAX ACCOUNTANT ASAP.

Also review how confident you are of your assumptions.  IPO's get pulled off the market all the time, and the prices companies go public at does not necessarily generate a return to common stock holders.  I can't give too much advice without more info, but if there's a lot of money at stake, you might want to consider staying until the IPO.