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What information you need to exercise stock options

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If you have decided to exercise your stock options, or are considering exercising, there are some pieces of information you’ll want to have handy before doing so.

While the process of exercising options is relatively simple — you’re paying your company to buy the options you’ve been granted — there are some things you’ll want to consider, because there could be further implications.

Specifically, you’ll want to know:

  • How many options you can and/or want to exercise
  • The base cost to exercise your options
  • The taxes you’ll owe when exercising your options

We’ll go through what you’ll want to make sure you have (and why), and where you should be able to find them.

What type of stock options you have and the strike price

First, you’ll want to know what type of stock options you were granted. If you don’t know, that’s OK. It’s not common for the type of options to be included in your offer.

But you should be able to find them in your grant document(s) or your equity management platform, like Carta or Shareworks. You should also see your strike price in the same place. The strike price is the cost to exercise, or purchase, one share.

There are three types of stock option

  • ISOs (incentive stock options)
  • NSOs (non-qualified stock options)
  • RSUs (restricted stock units)

ISOs are the most common for startups and pre-IPO companies. But it’s becoming common for later stage startups to switch to RSUs before going public. If you’ve received multiple grants during your employment, you’ll want to check all grants for the type of options you received in each.

If you’ve left the company and received a post-termination exercise window of longer than 90 days — sometimes 3 or 5 years, all the way up to 10 years — it’s likely that your ISOs have converted to NSO’s. You should be able to check this wherever your equity is managed.

The importance of knowing the type of options you have is due to the tax implications you may have when exercising your options.

How many stock options you’ve vested

Typically, you can only exercise the options you’ve vested. Your stock option grant(s) will include information about your vesting schedule. The most common is a 4-year vesting schedule with a 1-year cliff. That means, you’ll vest 25% of your grant after one year, and you’ll then vest a percentage each month for the next three years.

Do note that while this is the most common, some companies — especially later stage companies — have moved to shorter vesting schedules, sometimes only a year to vest everything.

Additionally, some companies may also offer early exercising. Meaning, you can exercise your options before they vest. You may need to ask if your company will allow this. If so, you may need to also file an 83(b) election within 30 days of when you do exercise.

Knowing how many you have vested will inform how many you can exercise at a given moment. To figure out the base cost (excluding taxes) to exercise your options, you just multiply the strike price by the number of options you want to purchase.

Your current financial and tax situation

You should know how much you’re comfortable investing in your stock options (yes, buying stock options is investing in your company) and the tax implications.

Yes, you’re likely not seeing any cash while your company is still private, but the federal government, and many state governments, will require you to pay taxes if the options you are exercising are valued higher than they were when they were granted to you.

Your strike price was set when you received the grant, but the value of those options — known as the 409A or fair market value — is likely to change. If the fair market value is higher than the strike price on the day you exercise, you’ll likely owe taxes on the spread.

This is why it’s important to know the type of options you have. ISO’s have a more favorable tax treatment (hence, incentive) and are subject to the Alternative Minimum Tax (AMT). NSO’s are subject to income tax.

There could be exercise and tax strategies based on your financial and tax situation. For example, you may be able to avoid AMT if the strike price and fair market value are the same (a benefit of early exercising). Or, you may be able to exercise a certain portion each year without paying AMT.

NSO’s are taxed as regular income and could, for example, bump you into a new tax bracket. You’ll want to know the financial and tax implications exercising could have beforehand so you don’t run into any surprises.

You can learn more about stock options and taxes in our dedicated collection.

The goal is to have a plan

Exercising your stock options is likely to be a major financial decision. It’s important to have all the information you need to make sure you’re as informed as possible before doing so.

Of course, exercising is also a personal decision and the factors that play into it will be different for each individual. But the most common mistakes people make are just not fully understanding the implications of exercising, like taxes, so it’s always best to put together a plan to avert any surprises in the process.

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