Startup stock option choices?

[thedayisbrave]

I just joined a startup and stock options were included as part of my compensation package.  Obviously a large % of startups fail, but I didn't really have much to lose - I'm still selling real estate in my spare time and can go back to that full-time at any point.

They vest over a period of 5 years.  I definitely don't envision staying that long as I'm an entrepreneur at heart and happiest when doing my own thing.  The "cliff" is 1 year.. so I will get 25% of my total amount once I hit the 1 year mark & then its monthly vesting after that.

It's an early stage start-up, just closed the seed round.  Based on my understanding, I can exercise the options anytime.  I've read that it may be better to hold for a year to turn them into long term gains but I'm not really sure how it all works.  There's a 90 day window for me to exercise after I leave the company.  How does this work for an early stage startup? If I exercise in a year and own x% of the company, what am I looking at - basically waiting for it either to get acquired or go public, right? If it's the first, how does the strike price get calculated?

Will continue to do more research but just thought I'd ask here too.  Thanks!

[Mother Fussbudget]

If it's a privately held company, you will have trouble exercising the options in any case as only the company can buy them, and they self-set the share price.  What you really want is for the company to be bought (possible), or for the company to IPO / go public (rare).

In case of a buyout, you will be offered to exchange your vested shares (and they will possibly accelerate vesting) for cash, or shares in the purchasing company.  In general, this is a taxable event, but if your company is being bought out for very large sums, you'll be happy to pay the taxes.

[Gen Y Finance Journey]

Your company will have set the strike price, so check with them on that. I think companies all behave differently when it comes to vested, unexercised options at the time of an acquisition or IPO, they may give you an opportunity to exercise them, pay out a (likely) small amount for them, or they may just disappear. My basic thinking is if the strike price is really low, as it probably is in a startup, you may as well go ahead and exercise them as soon as you can, especially if you don't have that many options and the total cost is minimal. You should also ask about the fair market value of the shares (though they may be the same as the strike price at this point) because if you exercise a lot of options and the difference between the strike price and the fair market value is significant, it could have alternative minimum tax implications.

Just be aware (and it sounds like you already are) that the chances of the stock ever being worth anything are pretty low, so figure out how much money you're willing to gamble on the future of the company.

[AZDude]

By the end of a year, chances are good you will know where the company is going, or not going. My one year at a start-up was fun(for the most part), but I knew 6 months in that it was only a matter of time until the company went under... which it did about 18 months after I came aboard.

[seattlecyclone]

The strike price should be set when you accept your initial offer of employment. Regardless of what happens with the company over the next few years, your strike price for those shares should not change.

If these are incentive stock options, there are some tax advantages to holding onto the shares for at least one year after exercise and two years after the initial option grant date. In addition, for purposes of the alternative minimum tax it's better to exercise the options when the fair market value of the shares is as low as possible. However this also tends to be when the risks in owning the stock are the highest. Don't let tax considerations have an outsized effect on your decision making.