ISO Stock Grant help

[tryathlete2011]

I received a stock grant from my company and I'm a bit confused on the best way to manage it. My net worth is nearly $700k and I have about $115k of that outside of retirement accounts. Mostly in VTSAX. The company is NOT public but we were told at the time our division was purchased that they had recently redeemed some shares for ~$9.00.

Ideally I would like to cash out as quickly as reasonable to invest in my normal plan (401k, ROTH IRAs, 529s, HSA and Vanguard funds beyond that). But I think it would be better to exercise, hold for a year and then sell to reduce tax liability? Would it make sense to exercise cashless (if possible)? Or save up and tie my own money up for the year. Or just let them sit and ignore them for the time being?

Some facts:
Granted 10,000 options (ISO) on Jan 1 of 2017
Exercise price $4.46
First batch vests on Jan 1, 2018.

[seattlecyclone]

This all depends on so many factors.

Under the current tax system, ISO shares receive special tax treatment if you sell at least two years after the stock grant and one year after exercising. Furthermore if you expect the value of the shares to increase over time, exercising sooner rather than later will reduce the amount that gets taxed for the AMT purposes before you even sell anything. If the AMT goes away next year, that latter point will become less of a consideration.

However taxes should not necessarily be your primary consideration. How liquid are these shares? Do you have any idea when you might be able to sell them? Do you have strong reason to believe that the company will ever get to an IPO? Exercising pre-IPO options can be a big gamble. I had pretty good luck with it with the company I worked for, but I've seen examples of companies that everyone thought would go public within a year, and five years later they still hadn't. And of course there's always the possibility that the company goes bankrupt and your shares become completely worthless.

You need to take a long, hard look at your company, how likely you think each of these scenarios is, and make a decision according to those probabilities and your own risk tolerance. Worst case, you exercise all the shares (putting 6% of your net worth into them), and the company goes bankrupt. Probably wouldn't feel great, but wouldn't be the end of the world either.

I don't think that a so-called "cashless exercise" ever makes much sense. That transaction essentially involves selling a fraction of the shares immediately in order to pay for the rest, which you would keep. If you think the shares are a screaming deal and you want to hold them a year for maximum benefit, then put up your own cash to buy and hold the whole lot. If you want to drop the shares like a hot potato and reinvest in index funds, do that. Don't keep whatever fraction could be exercised cashlessly.

[tryathlete2011]

Thanks you for the thoughtful reply. To answer your questions...


How liquid are these shares? Do you have any idea when you might be able to sell them?
I don't know. Who would I even ask?

Do you have strong reason to believe that the company will ever get to an IPO?
I would say I do not have a strong reason to believe it. I would put the odds around 50/50 but that is mostly a guess.


I don't think that a so-called "cashless exercise" ever makes much sense. That transaction essentially involves selling a fraction of the shares immediately in order to pay for the rest, which you would keep. If you think the shares are a screaming deal and you want to hold them a year for maximum benefit, then put up your own cash to buy and hold the whole lot. If you want to drop the shares like a hot potato and reinvest in index funds, do that. Don't keep whatever fraction could be exercised cashlessly.
I don't feel like its an incredible deal, but also feel its more than likely to make some decent money. Would it make sense to drop say $1000 a month to exercise and then sell that batch once it hits 1 year (assuming I'm able to)?

[seattlecyclone]

How liquid are these shares? Do you have any idea when you might be able to sell them?
I don't know. Who would I even ask?

Start with your manager and/or someone who does payroll. One of them might be able to point you in the right direction.

I don't think that a so-called "cashless exercise" ever makes much sense. That transaction essentially involves selling a fraction of the shares immediately in order to pay for the rest, which you would keep. If you think the shares are a screaming deal and you want to hold them a year for maximum benefit, then put up your own cash to buy and hold the whole lot. If you want to drop the shares like a hot potato and reinvest in index funds, do that. Don't keep whatever fraction could be exercised cashlessly.
I don't feel like its an incredible deal, but also feel its more than likely to make some decent money. Would it make sense to drop say $1000 a month to exercise and then sell that batch once it hits 1 year (assuming I'm able to)?

If it were me, having gone through this before, I would want to have some confidence that an IPO (or other opportunity to sell shares for more than the strike price) would be happening within a year or two before purchasing any shares. If AMT goes away, there's no tax advantage to buying your shares more than the minimum one year in advance of selling in order to get the ISO tax benefits. Keep in mind that a six-month lockup after IPOs is pretty common, so exercising any point more than six months in advance of the IPO would get you the full ISO tax break if that applies to you. Exercising any earlier than this exposes you to a bunch of risk for little reward in exchange.

[plog]

I would never expend real money for private equity that left me with no power.  Please, use that term instead of "stock".  There is no market for this which means you have no way of selling it or getting an accurate valuation--you rely on the company itself to do both of those things---and guess what's in their best interest?

I know this is just an anectdote and not data, but I know 3 people currently sitting on private equity from past employers (2 different companies) that were to go public and get them cashed out over 18 months ago.  All still waiting.  1 took their own money and bought the options, the other 2 thought they were being smart and were able to immediately excercise/sell  some options to excercise/buy the others.  That way it didn't cost them any of their own money.  Well, until January came around and they had a tax bill on the short term sale of the options they exercised/sold. 

I know its probably not a lot of your net worth you would be expending, so it won't be  a horrible mistake.  But I want cash on the barrel head from my employer, not promises so I never play this private equity game they set up and run. 

[tryathlete2011]

This is super helpful, thank you. And to be clear, this wasn't something I negotiated. My company was purchased about 14 months ago and in addition to keeping our salaries the same, etc., they granted us this equity. I didn't really pay much attention to it until they told us it was about to begin vesting.

Would your recommendation be to just ignore it until/unless the company goes public.