Leaving a Start-Up Company: What to Do With Your Stock Options?
October 25, 2016
The decision to leave a start-up carries with it a host of considerations that differ significantly from the choice to depart from an established public company. Specifically, if you are considering leaving your start-up company, there are important issues surrounding your stock option plan that should be addressed. It is easy to focus solely on the future value of the start-up company when evaluating your options; however, you should not overlook the personal financial implications of exercising your options, nor the terms embedded in your company’s plan. Electing to exercise your options, to the extent that they are vested, is a tricky decision particularly if the shares are illiquid due to a distant IPO or lack of a private secondary market. Furthermore, there are financial risks to paying out-of-pocket for an option exercise that leaves you holding illiquid shares, with depleted cash holdings and a potential outstanding tax bill.
Whether you choose to exercise your vested options or not, pay close attention to the time allotted to make such a decision, which is typically between 60 and 90 days from your date of separation. If you left under the terms of a layoff, you may receive a severance package that lasts six months or more, but be careful to not confuse the terms of that package with the expiration date on your stock option grants.
Another important step is to review your document for the company’s repurchase right. A repurchase right gives the company an “option” to buy shares back from the shareholder under certain circumstances and most typically upon our termination from the company. The company is not required to exercise this right, but if it does, it must repurchase the shares from the shareholder. This repurchase would apply to all vested options, as unvested options do not vest once employment termination has occurred. If this clause is in your compensation agreement and the company exercises this right, these options revert to the company automatically.
Taxes are a potentially large and costly consideration when reviewing your stock option decision. Options come in two forms – Incentive Stock Options and Non-Qualified Stock Options – with differing impacts on your taxes. Prior to any option decision, you should request that your tax advisor review the implications and timing of any exercise. Depending upon your personal situation, the Alternative Minimum Tax (AMT) can further complicate the tax circumstances of your decision. Ultimately, any tax burden from a stock option exercise is a drain on your liquid asset base – the same asset base that will also need to pay for the immediate cost of the options.
Taken together, these factors – the cash cost of the option and any resulting tax burden – can impose a significant drain on your personal finances. A lack of investable cash for liquid and diversified assets can challenge your overall ability to accumulate wealth over time, and to the extreme, can jeopardize your ability to meet your standard living obligations. The cost of exercising your options could also mean foregoing or depleting retirement savings, which is always a risky proposition. Holding a concentrated and illiquid stock can make sense if appropriately sized and within the context of a greater asset base, but considering an option exercise that threatens your ability to pay living expenses and fund retirement requires a closer look.
Weighing the out-of-pocket expense, opportunity cost in the use of cash assets, risk of loss and potential benefits becomes the priority in your planning. Of course, life circumstances and other opportunities often dictate decisions beyond the financial implications. Each individual’s situation should be handled carefully with the help of investment and tax advisors.
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