Author Topic: Employee stock options (NSOs) at private company: exercise or let expire?  (Read 1410 times)

markus

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Hello Mustachians,

I currently have several packages of employee stock options with my private employer, all of which are non-qualified stock options (NSOs or NQSOs), and the first of which will reach its expiration date this year, just a few months from now. The options in this first package are fully vested at this point.

I've put off any decision about whether to exercise these options or not until now, and the more I read and understand about employee stock options, the less inclined I am to exercise, instead leaning toward simply letting the package expire. I wanted to list my quick pro/con list on this decision here in order to quickly plumb the depths of experience and perhaps expertise of this forum, so thank you all for any insights! I'll take it all as free advice and promise not to shake my fist at you later in life because of some big regret regarding this stuff. : )

Without getting into specific numbers, exercising these options would require an outlay of low six figures. I don't keep that kind of money liquid, and I'm not willing to touch any emergency fund's money to produce it, so this would require me selling off some stock in my taxable account. Bonus season is coming up and it's possible that such a bonus could provide a good chunk of the required money, but I've always preferred to instead sock away at least two-thirds of any windfall into my investments according to my AA, so I'd be reluctant to 'gamble' it like this.

Here's my quick pro/con list on whether or not to exercise my options:

PRO
- one day make a bunch of money very quickly (maybe)

CON
- opportunity cost ... low six figures worth of funds that I won't have invested at my usual AA, not producing dividends, etc.
- additional taxes ... the act of exercising the options is a taxable event, requiring tax payment on the value of the options at their strike price, so my cost to exercise already becomes significantly higher than just the value of the options, so opportunity cost above is even greater.
- my employer is private ... thus there is no secondary market to sell my options into. A purchase or IPO would have to take place, and that may never happen, leaving my stock effectively locked up. I still lose that tax money.
- or my employer eventually does sell or IPO ... but the stock price falls, leaving me either underwater and unwilling to sell, or even folding entirely and taking my stock with them. I lose the investment and the taxes I paid, too.
- more stock options could be issued in the meantime ... this further dilutes my shares, reducing their value.
- my employer is private ... valuing the company is complex and possibly unknowable for a layperson like myself
- IPO or purchase event would still entail a 'lock up' period ... so I couldn't immediately turn around and sell my shares, thus it becomes a gamble over time whether they're still in the money by the end of the lock up period.
- original shareholders and equity investors get paid first ... understandably, those who invested early are going to get paid back first, or even with a guarantee that they make their investment plus some additional amount. Any potential gain of my own would come second.
- taxes on any gains due at time of sale ... so I pay taxes first on the exercise, and later pay tax again on any gains. While there's still potentially a profit at the end of all that, that's an even bigger chunk taken out, so again I see it as opportunity cost. Oh, and long term capital gains paid on liquidating part of my taxable investments, too! Sheesh.
- owning stock in this one company would equate to a high single digit of my net worth, and this goes against my AA.

Obviously I'm a bit wary of exercising my options, maybe even pessimistic, as the rather CON-heavy list above illustrates. But I'm curious from you all whether there are other PROs that I'm not considering. What about my faith in my employer ... do I think they've got a bright future ahead, or do I believe in their ability to continue to produce and turn greater and greater profits? Actually yes, I think they're likely to continue to succeed in their business.

But is that enough that even if everything with these options goes according to plan, and their value doubles (and even that seems a bold assumption) or greater? Well, this is the key part I keep coming back to: If I just had left that money invested along with my normal AA, I'm probably going to make that same 'profit' over the course of a few years regardless, simply staying the course. That's where I really lean toward simply letting these options expire, not wanting to essentially take a piece of my 'stache and buy what seems to me is a lottery ticket but with slightly better odds.

I should also mention that I've still received bonuses on occasion over the years, and my compensation is good. I've worked very hard for this company for a long time now, and I still feel that this work has been recognized, so while I'm sure there's some amount of money that might have otherwise been offered in bonuses or compensation, these options don't necessarily feel like they're offered in lieu of more concrete rewards. This isn't a startup scenario where compensation is low but options are plentiful or something like that.

That's my situation. Thank you all for digging into this one and for any advice you take the time to share. I'll look forward to learning a few things.

NorCal

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You're right, this is a complex decision.  Questions:

Question #1: How senior are you, and are there a lot of people in a similar situation?  If so, it's fairly common for companies to come up with workarounds if management cares to deal with it.  I've known companies to either extend the exercise period, or arrange for share re-purchases (typically an existing investor will buy the shares from you).  This is all fairly common stuff, but it requires management to deal with the board, and it costs a little in corporate legal fees.  If you're senior enough, or there's a lot of people in your position, ask.

Question #2: Do you have a sense of what the stock is worth compared to your exercise price?  That will tell you a lot.  Ask to see the current 409a valuation.  If they won't share that, ask a new hire what their exercise price is.  If the current value is 2x or 10x your exercise price, exercising options is a lot safer than if your exercise price is close to the current value of the shares.

Question #3:  You seem to be thinking of this as an all-or-none exercise.  Is there any reason you wouldn't exercise a portion of the options that you're comfortable with?

If it were me, I would make a fairly big deal to management about this.  Try to make it their problem if you can get away with it.

If that doesn't work, I would base my decision on the difference between the exercise price and the current value.  If the exercise price is close to the current value, I wouldn't exercise.  If the current value is 100x the exercise price, you'd be stupid not to exercise.  If you're somewhere in the middle ground (which is most likely), I'd exercise a portion of shares based on my comfort on having money locked up.

My wife is a lawyer that deals with this stuff on a daily basis.  Feel free to send me a DM if you have specific questions.

seattlecyclone

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Good advice above. I wouldn't buy and hold more than I could afford to lose, but look into alternatives before deciding just to let the options expire.

Off the Wheel

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NorCal had excellent, practical advice. Here's my more emotional advice.

Employee options in underperforming companies with no exit strategy aren't worth much. I've passed on exercising those packages, because I knew we were hugely diluted with multiple rounds of big investments, that our business model wasn't sustainable (still not profitable 5 years in), and that we had no concrete exit strategy.

Employee options in highly performing companies with clear exit strategies can be worth a lot. I live in Vancouver, the land of lululemon and plenty of tech companies, and employee options led to a lot of un-intended FIRE for a lot of those first yogis and tech bros. I'm currently in a company where not only would I exercise my options, but I've also invested further into the company. The reasons I feel that way are:

  • I have full visibility into the business model and finances. We're profitable, we've got strong partners in the 'tricky' sides of the business, and we're growing quickly.
  • We have already started discussing the 3-5 year plan of acquisition or IPO, and there have been several examples in our industry recently of both.
  • I'm an early employee with a decent share, and we're focused on not diluting the base (have fewer than 10 outside investors with less than $2M raised)
  • The option price has already gone up from my package (I know this because of what the last investment round went at) - up 50% in a year, at a very conservative valuation, would already give me a $40K profit

However, perhaps most importantly, I see this money as a my 'fun' investment money, where i can try riskier things. The same way I would look at crypto. Great if it works out, no big loss if it doesn't. I don't keep track of this investment in my overall FIRE calculation.

If I were you, I would try to get as much information on the financials as possible, determine the exit strategy and viability of that strategy, and if those factors are still unknown, see if you can postpone the exercise date.

markus

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Question #2: Do you have a sense of what the stock is worth compared to your exercise price?  That will tell you a lot.  Ask to see the current 409a valuation.

Thank you, NorCal. I'm going to pursue the 409a, and thanks for suggesting it as I hadn't stumbled on that yet. I don't expect I'll be able to shake any info out of newer hires as we're a fairly large company at this point, so I'd have to guess which of the more senior people might have been presented stock options, and I'm pretty sure none of those people are going to be willing to discuss them. But I'll check out the 409a angle.

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However, perhaps most importantly, I see this money as a my 'fun' investment money, where i can try riskier things. The same way I would look at crypto. Great if it works out, no big loss if it doesn't. I don't keep track of this investment in my overall FIRE calculation.

This is the aspect I perhaps hesitate on the most. My current portfolio has me well past 'FI' and now almost touching my own definition of being ready to 'RE', which in a nutshell is FI plus a number of safety margins. I have a rough plan to step away from my job in perhaps a couple of years depending on certain project dates, and if I leave things as they are then that plan is looking very good, granted the market could always tank between now and then. Hence my increased reluctance to potentially set those plans back another year or whatever the exercise money equates to. Knowing I'm in a position to walk away from my job has actually been a good strong wind in my mental sails when I'm feeling burnt out.

Nevertheless, I totally get your point, and as you and NorCal both suggested I could always exercise just a portion of this package and thus risk less. If I can get a sense of the company's value then that's probably the best 'middle of the road' course of action, plus it would sit better with my IPS. In the end if I decide to just let this package expire, I've still got another which is also fully vested and has another couple of years before its expiration, so there's another opportunity not far down the line that I could perhaps plan ahead for as far as having funds liquid and ready to commit.

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Thank you all again for digging into this one and for your input. Best damn forum on the internet!

JohnGalt

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You've gotten great advice so far.

I noticed in your opening that you talked that you mentioned the risks that exist but didn't seem to put much of your own thoughts on the likelihoods.

How is the company doing?  Are they moving towards any sort of liquidity event? 

If the company is just floating along and you don't see them charting a course towards a liquidity event, I wouldn't put anymore than "fun" investment money into it unless management is willing to put something (ideally binding) together around repurchases or other alternative ways to cash out ownership.

As someone who's employer went through an IPO last year (so I may be biased) - there's a lot of upside.  At the same time, if you're basically at your number anyways, no need to take unnecessary risks.
 

NorCal

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Nevertheless, I totally get your point, and as you and NorCal both suggested I could always exercise just a portion of this package and thus risk less. If I can get a sense of the company's value then that's probably the best 'middle of the road' course of action, plus it would sit better with my IPS. In the end if I decide to just let this package expire, I've still got another which is also fully vested and has another couple of years before its expiration, so there's another opportunity not far down the line that I could perhaps plan ahead for as far as having funds liquid and ready to commit.

Be sure to check the exercise price on the old grant vs. the newer grant.  There could be dramatically different economics between them.  It's possible you could be underwater on one of the grants, but have major upside on the other one.