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For many startup employees, equity compensation could be their biggest financial asset — and they may not even know it.
Stock options are extraordinarily valuable, but also widely misunderstood. They’re illiquid, not to mention they don’t come with a guarantee of an exit event (aka cash value). Due to these and other factors, many startup employees think of their equity as “funny money,” assuming equity isn’t worth anything until the company IPOs. Or, on the other end of the spectrum, some employees believe that unless they’re going to become a “Microsoft Millionaire” from their stock, it’s not worth it.
But this way of thinking can impact the potential your equity can have. An IPO may not make you a millionaire overnight, but it can bring you a sizable amount of wealth. And your shares may be illiquid now, but there still could be ways to fit your equity into your financial plans in the short- and long-term.
Perhaps most reassuring of all, exercising doesn’t have to be an all-or-nothing-game. You always have choices.
And deciding not to do anything — to not think about it, or to not make a plan — is a choice. Maybe you exercise all your options now, some of them now, or none of them now. There is no one-size-fits all strategy, because what’s best for one person may not be what’s right for you and your specific financial situation.
The goal of having a plan is to help you minimize taxes and maximize gains without sacrificing your near- or long-term financial goals.
By incorporating your stock options into your broader financial plan now, you can potentially save yourself tens of thousands in tax dollars down the road — not to mention accomplish your life goals sooner than you might have thought was possible.
In this article, we’ll walk you through how you should think about your stock options and some questions to ask yourself to make an informed decision about what to do with your equity.
Remember, stock options are both compensation and an investment. Yes, stock options are part of your comp package. But what you’re really being given is the opportunity to invest in your company at a (very likely) low cost.
The attractive entry point is the investment, and the post-exit windfall (fingers crossed) is the compensation. Your strike price is based on the 409A valuation, or fair market value, when the stock was granted and will never change. But the 409A likely will increase, even before an IPO or exit. It’s also likely less than the preferred price that the company’s investors receive. Your strike price is a discount in itself, as it’s a discount from the pref price that investors get. And then on top of that, hopefully you’re buying at a discount pre-IPO.
A better way to view your stock options is with an objective lens, evaluating it as you would any other investment. And if you would like an unbiased perspective prior to making this decision, we're here to help.
It’s easy to be biased toward the company you work for — both positively and negatively. As best you can, you’ll want to remove emotion from the equation and, with the knowledge you have (as an insider, you likely have more than those that don’t work there), think about your company from a critical point of view.
Consider things like:
Sometimes, people may feel positively about their company, the trajectory of its future, and the job they’re doing. At the same time, they think it’s best to wait to do anything with their equity — until an exit is near, until the public markets aren’t volatile, until they save more money, etc. Generally, if you think the company (and your role in it) is worth it, you should feel the same about your equity.
By evaluating your company in an unbiased way, you’ll be able to clearly articulate when and why you want to invest in your company by exercising your options.
An IPO may not make you a millionaire overnight, but it can be your entry into wealth to help you achieve big goals, like buying a house, or building the foundation for a retirement, or it can enable you to achieve small goals, like taking time away from work to travel around the world for a few months.
You want to understand how your equity can help you achieve those long-term and short-term goals. That’s why it’s important to ask yourself what you hope to accomplish with your money, especially if you haven’t really sat down and thought about it.
What do you hope to accomplish in the next five years? Ten? Twenty? Common goals are home purchases, car purchases, big vacations, weddings, education funding, charitable donations, and retirement, but they can be anything you personally aspire to, like starting your own business.
Not all of your financial goals have to be big-ticket items either. Maybe you want to go out for a special date night with your spouse once a month or take a fun trip with friends from college. Planning out your goals — big and small — helps you prioritize them and evaluate where to put your money.
If you were to work with a financial advisor, they would assess your goals and then develop an investment plan to help you achieve them. For example, if you're dedicating funds for your newborn child's college education, your advisor might recommend investing this money into a more aggressive, long-term investment portfolio than if you're wanting to purchase your first home in two years. Next, he or she will help you align your current financial situation with your goals.
The same approach holds true for making key investment decisions regarding your stock options. If you want to purchase a home in the next six months, it may not make sense to spend most of your savings to exercise your stock — even if you (and your financial advisor) believe it’s a good investment. But, if you plan on leaving your company soon, you can develop an exercise plan that will help you re-prioritize exercising your equity so you don’t forfeit it.
Equity isn’t a take-it-or-leave-it thing. Instead, you want to understand how it fits into your overall financial portfolio to better understand how you value it today, and tomorrow.
Exercising earlier usually comes at a lower cost due to lower tax implications, but it can have higher risk because your company is further from an IPO or exit. Waiting could reduce the risk of “failure” but it could increase your investment cost exponentially.
Not everyone’s risk tolerance is the same. Some people are more willing to take risks than others, and some people judge risk on a case-by-case basis. Plus, your risk profile is likely to depend on your financial goals, as determined above.
Planning is not one-size-fits all, and money is finite. How you allocate your wealth is up to you and should be rooted in your goals. This is where a personalized, goal-based plan is invaluable. For example, if you are looking to purchase a new car within twelve months, you may not want to tie up your savings into your equity if your company is years away from an exit.
Then, there are a myriad of tax considerations that can save you tens of thousands in the long run. How do you plan for AMT? How could NSOs impact my income tax liability? These are the short-term risks you want to consider, while also managing your longer-term risk appetite.
Minimizing costs and taxes (and maximizing gains) shouldn't be the only consideration. It’s also about what makes sense to you and your plan. And “missing out” on more gains or lower taxes doesn’t mean you made a “bad” decision. It means you made the right one for you.
Talking through these questions with an advisor will make a world of difference in your outcomes. A certified professional can help you navigate these decisions to better help you understand your own risk profile, and where you want to make your big bets and where you want to be financially safe.
Do you think the company will exit soon? Do you think the valuation will increase or decrease between now and then?
It’s easy, as a current or former employee, to have a biased view of the company. That makes sense! You’ll also have more information than somebody who didn’t work there. But try to remove emotion from the equation to think about what a company exit could or would look like.
Again, your stock options are an investment opportunity in your company and should be treated as such. If you think your company is worth investing in, that’s great — go for it! But if not, there’s no reason to force the issue.
The answers to these questions about your company could also impact your financial decisions, or risk profile.
At the end of the day, there is no single answer to the question, “Are my stock options worth it?” Really, more accurately it's, “Are they worth it to you?”
By laying out your goals by timeline, evaluating your company like any other investment, and mapping your exercise strategy to your overarching financial plan, you can determine which exercise strategy is right for you. Your equity is an asset that you can use now, and it doesn’t have to be an all-or-nothing decision. An advisor can help you understand what timing and tax moves make sense for you.
Not only will you gain peace of mind in building your exercise strategy into your financial plan, you’ll also gain more flexibility in your life to evaluate career opportunities and enjoy near-term goals. If you’re interested in chatting with an advisor about creating your own plan, we’d love to hear from you here.
Continued reading: The complete employee stock option starter guide
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