Author Topic: Question about private company stock option  (Read 510 times)

zenath

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Question about private company stock option
« on: January 03, 2019, 01:24:31 PM »
My company has recently opened up a stock purchase program for employees. This company is private and will remain anonymous. I have provided some numbers as examples, but these are not exact figures. I am debating what to do with this program. The basic idea is the following:
  • The shares are treated as normal shares for most intents and purposes except the only buyer/seller is the company. Employees are not allowed to trade shares to anyone except to resell them to the company.
  • I am allowed to purchase up to 5,000 shares at $5 a share.
  • The company will purchase 25 shares for every 100 I purchase.
  • There is a vesting schedule of 5 years with 1/6 of the shares vested on purchase. This only affects if your trying to sell or leaving the company. Basically you'll always get your principle back if you leave, but you only get the appreciation on the vested shares. There is no principle investment on the bonus shares and you get the portion of them according to the vesting schedule. If selling shares, you can only shell the vested shares and they should be taxed at the capital gains rates.
Overall there is a lot of upside (appreciation as well as 25% bonus), but this is more money than I have on hand in my emergency fund. They offer a loan program where you can take out a loan for 80% of the share amount at ~3% with interest accruing monthly, but interest payments only due EOY (coincidentally when bonuses are handed out...). Thus I can pay $5,000 to buy $31,250 worth of shares (5000*1.25*$5) and have a loan of $20,000. I can afford the $5,000 hit by temporarily dipping into the emergency fund.

I am confident in the company performing well, historically doubling the private stock value over a 6 year window. With that said, I expect the stock appreciation to slow down to closer to the stock market. My other hesitation is that I am still dealing with the after effects of some burnout over the past year. As a result I had a mini-breakdown where I was tempted to just quit, but was freaking out about the mortgage (the only debt I currently have).

Also, I would need to pay some short term capital gains on the purchase of stock this year since they will soon be announcing the appreciation and I will get to purchase at the pre-appreciation amount. You wouldn't pay taxes if purchased last year, but they finalized this while I was on vacation this Christmas break. Finally, I had a lot of appliances broke this winter and the house needs a roofing replacement this year. Thanks to being Mustacian, I won't go into debt, but I won't be saving anything in the interim.

I am curious about other advice. Mathematically I know this works out positive even if I leave before the 5 year vesting. Leaving before the 5 year vesting just reduces the appreciation I can get. However, I have become rather debt adverse and cash flow conscious since that has had the biggest impact on my sense of safety. I am a bit concerned that the loan is not backed by the stocks, but is treated as a personal loan.

One way I look at this is that I am paying $600/year ($20k*0.03) for $1,250/year in bonus share vesting plus appreciation. However, the $600 needs to come out of my pocket now and the $1,250 is only available in the future.

Any thoughts are appreciated. Thanks!

Cranky

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Re: Question about private company stock option
« Reply #1 on: January 03, 2019, 01:48:38 PM »
I think it is possible that my dd and I were just discussing the same program. ;-)

I canít speak to the financial analysis, but I donít think that Iíd borrow money to buy these, personally. I might lend my dd some money to buy them, though.

So Iím really zero help, but it seems like a better deal than bitcoin.

secondcor521

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Re: Question about private company stock option
« Reply #2 on: January 03, 2019, 08:35:08 PM »
I wouldn't touch it with a 10 foot pole.

First, it's your job.  Generally not a good idea to tie up very much of your NW in your employer's stock because it concentrates risk.

Second, it's a privately held company, and you can only sell your shares back to them.  This will be at a price they set, not you, and only if they want to and only if they can.

That's the last bit.  Unless you can get audited financial statements or original tax returns and bank statements (which I bet they won't give you), you really only know what they're telling you about the business.  Based on the structure you outlined, it really sounds to me like they could be short on cash and are financing the company through selling (potentially worthless) equity to you in exchange for them keeping the money from your paycheck.

And then they have the gall to suggest that you can pay them 3% interest on the money you're effectively loaning them!  Very odd, and honestly confusing!

If they're not willing to accept the stock as collateral for the loan, what does that tell you that they think the value of the stock is?

Finally, if you have a leaky roof and other appliances that need fixing/repairing/replacing, you don't have the money to invest in anything.  Fix your house first.

I wouldn't do it, and I'd probably start asking questions to find out how the company cash flow is doing and why they aren't seeking traditional bank funding via a line of credit or something.

I'd also consider brushing up my resume and trying to beat my fellow employees to a new job elsewhere.

clifp

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Re: Question about private company stock option
« Reply #3 on: January 03, 2019, 09:00:14 PM »
A couple of question is this an ESOP (Employee Stock Ownership Program)?  If so those are generally good deals and regulated by the IRS.  They are designed to be a win/win for both employees and employers, offering significant tax breaks to employers and access to inexpensive capital and good deal for employees.  As added bonus in my experience make employee part owners of the company has definite benefits.

You are getting 5% a year bonus returns, (25 shares/5 years) that's nothing to dismiss.  When smart people like Jack Bogle are forecast 4-6% stock market returns and bonds pay 3% you are doubling you effective returns. 

I agree with @secondcor521 I wouldn't invest in the program unless they shared with you the financial, I am not sure if they are required by law to do so.  But it would certainly be a red flag if they didn't.  Is the amount of money $600?  If I so I'd do it.  You do want to be careful and keep the percentage of your net worth in company stock to a reasonable level 20-25% max. 


zenath

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Re: Question about private company stock option
« Reply #4 on: January 04, 2019, 11:53:22 AM »
@secondcor521 They did provide financial year 2017 and 2018 data. Without disclosing actual numbers, the debt level is healthy and all of the current assets are equal to outstanding equity. This is an IRS 83b Election and it seems that this would provide quite an equity injection in the company which is why I predict the appreciation to slow. I am not worried about the company imploding. The loan is an option not a requirement.

With that said, I do see your point and it was the other voice that I'd been debating. I trust the company and believe in the long-term viability, the timing just is not ideal.

@clifp this investment would be ~15% of my net worth. I just maxed out all IRA/401k vehicles last year and will continue to do so going forward. The only difference is that this would be my only non-retirement investment (for now). So it would likely be 100% of my after tax investment for at least this year. I've been focusing on 401k for the tax benefit anticipating I could always use rule IRS 72t or Roth Conversions to get access to the money before retirement if enough is saved.

clifp

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Re: Question about private company stock option
« Reply #5 on: January 04, 2019, 05:42:09 PM »
I'm not familiar with 83(b) at first glance it seems like good deal for the company and founder as long as the company valuation goes up.
Being able to borrow the money at %3 is a feature not a bug IMO.
Overall it seems like a good risk-reward ratio for me.

Worse case, you lose $25K +3k interest and you've set back FIRE by a <year
Nominal case the stock doubles in 5 years and you've spent, $5K +3K in interest to have stock worth $62,500 and you've accelerated FIRE by more than year.
Even if the stock stays flat you've still spent $8K over 5 years to end up with $31,250 stock and decent $3,250 profit. That's a cool 9.67% internal rate of return.

That's doesn't even talk about the potential of the stock really taking off and going up 3-5x over the next 5 years when the company gets acquired.

Grafter

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Re: Question about private company stock option
« Reply #6 on: January 05, 2019, 06:23:15 AM »
I will start with the caveats, that I'm doing this for funsies and that if you want actual tax advice, to talk/consult with a tax professional.  That being said, I would want to know a lot more:

-  How is this company taxed?  As this may impact your personal tax situation.
-  Has the company historically paid any dividends or distributions?  Or is it just a illiquid stock with the hope of appreciation?
-  When you say normal shares, you mean normal voting shares, correct?  If so, is there only one class of stock, or are there different classes with different rights (such as some shares with more votes)?
-  Just to confirm, but the company will award you one share for every 4 you purchase (or 25 for 100)?
-  What sort of financial statements did you receive/were able to look at?  Was it just a print out of a balance sheet and income statement?  Or was it full, footnoted financial statements, that have assurance from an outside CPA firm?  Just an FYI, an audit opinion is the most assurance, followed by a review report, and compilation provides no assurance.  The CPA report should be on their letterhead and will mention what services were done.
-  How is the purchase price calculated?  Is it done by a 3rd value business valuation agency?  Is it a qualitative formula based upon financial numbers (such as book value, or some combination of book value, net income and potentially some multipliers)?
-  If the company is the only buyer of shares, what is the re-purchase price?  Is it the same price that they sell at?  Or is there a haircut, so as to provide employees with liquidity?
-  Is it mandatory that employees that quit sell their shares back upon leaving employment?  Or can you hold onto them?  (Though then I would want to know the mechanics with the vesting schedule, such as if you get a partial cash out for un-vested shares)
-  You said that this program was "recently opened".  Do you mean that the company just started it?  Or that you became eligible for it?  As my understanding is that there needs to be a number of written documents related to such a stock purchase plan, and therefore, I would suggest if you are interested in pursuing this (or determining if you want to invest) that you obtain and read all such documents.
-  What do you think about the company's prospects for the future?  Has it slowly been growing earnings and size year or year, or is it in a cyclical industry, where there are booms and busts and some years where it losses money.
-  Is this an ESOP? 
-  How many shares are being offered under the plan, in relation to the total shares of the company?  Basically, will there still be majority shareholders after this (that control at least 51% of the votes)?
-  Does the company supply the loan to the employee for the 80% of the shares?  Or have they partnered with a bank to provide this?
-  Do you see yourself at this job in 5 years?
-  How often will they offer such?  Is the buying period only once annually?  How often can shares be sold back?  Can all employees participate?  Or only a select few?
-  If you pass now, will you be able to take advantage of this in the future?  (as this could drive fear of missing out)

Also, the 83(b) election is a personal level election, not a corporate level one.  You can google it for more of the details, but basically, once you are granted the bonus shares (which sounds like it is upon purchase; this is not when they vest) you can make a 83(b) election within 30 days.  The result of this election, you would have to pay tax on $6,250 (1,250 bonus shares and the $5 current price) at ordinary income rates in the year you were awarded the bonus shares/when you purchase the other shares.  The upside of this election is that you don't have to pay tax when the shares vest and the holding period for LTCG starts when awarded, not when they vest.  However, the downsides of this election is that if the company folds, or if you leave employment before all of the shares vest, you are out the tax you paid initially (and I don't think there is a way to recover it).

Though, to circle around, if I was in your shoes, besides getting the above questions answered.  I would really have to juggle the needing to go into debt to do so, having a large amounts of your eggs in one basket (as both your job and a significant amount of NW would be with the same company), wanting to be debt free, and also look at up coming expenses.  Personally, if I was good with the company, I would probably invest less than the maximum (but then, I am also not adverse to taking on debt for such an investment, especially at a guaranteed 3% rate).
« Last Edit: January 05, 2019, 06:27:00 AM by Grafter »