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Ask HN: Planning to leave. How best to handle stock options?

154 points by throwaway68080 ↗ HN
(I'm sure this has been asked before, but I must be bad at search, because I couldn't find the advice I was looking for).

I'm planning to leave the company I joined about 7 years ago as one of the first dozen or so employees. I have some options that are worth $X,000,000 as of the last tender offer, and would cost $X0,000 to buy. Exercising them isn't a problem, but I doubt I could handle the taxes. The company itself was valued in the $500M-$1B range in the last funding round. I'd hate to leave the options behind, but even if I could afford them, that's a ton of money to put at risk.

Does anyone have any experience with ESOfund? I've also heard that there are other private groups who help fund employee option purchases and taxes, but I don't know much about them or even whether it'd work with my employer. Besides those, any other advice on what the best things to do are here?

106 comments

[ 3.2 ms ] story [ 181 ms ] thread
jeffmould
I am neither an accountant or lawyer, but this may help:

https://blog.wealthfront.com/exercise-stock-options-taxes/

I can't speak for ESOFund, or similar companies, as I have never used them. My best recommendation would be to talk to a tax accountant and explore your options. You may also consider a secondary market sale now if you are allowed by your company.

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seattle_spring
He will be on the hook for an absolutely huge AMT tax bill.
jdross
Only once you exercise those vested options, which would presumably not be until after IPO
rhc2104
But this person wants to leave, and presumably he/she only has 90 days after leaving to exercise.
jonathankoren
If he leaves now, then he'll have to exercise sometime in the next 30-90 days depending on what the terms of the ISOs are. If he doesn't, they all revert back to the company.
gesman
Certainly the risk of $X0,000 is here.

"Valued" has no meaning unless the company is publicly traded or there is a qualified exit.

There must be a marketplace to "sell" tax bills for a chunk of options?

carbocation
The risk of 0.28•$X,000,000 is there due to alternative minimum tax rules, which is much worse and more immediate than what might happen to the $X0,000.
zinssmeister
You can exercise a portion rather than your entire batch of options.

You can possibly arrange with the IRS to pay your tax bill over time.

You can find a buyer that will allow you to sell right after exercise.

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eloisant
I'd say don't exercise them if you're not prepared to lose all the money you put in.

Calculate the expected gain in the best base to see if it's worth taking the risk. If there's a chance you become a millionnaire if the company does well, then maybe it's worth the risk. If at best you can do a x2, maybe not.

I've seen tons on company ending up on a low-ball exit (i.e. sold for less than what was invested) and see all common stocks nullified so the investors can recoup some of their loss.

epynonymous
you'll still take home a large payout even after taxes have been deducted, i would not worry about that, would be more worried about when/if the company either goes public or gets acquired.
carbocation
> you'll still take home a large payout even after taxes have been deducted, i would not worry about that, would be more worried about when/if the company either goes public or gets acquired.

But they will be on the hook for an AMT bill in April which will likely be worth 3-10 years worth of their current annual salary. The tax question is by far the most important question for this individual. The question of losing the $X0,000 that they put into the options directly is a rounding error.

quotha
How could the tax bill be greater than the amount earned?
vessenes
It's not, it's just that the 'earnings' are highly illiquid.
landryraccoon
It is very possible to lose more money than you earned. The OP may have to pay taxes against the valuation of the company, even if he isn't allowed to sell the shares. Then if the company drops in value, he could easily lose money on the difference.
fasteddie
OP isn't gaining any money from this. They are excercising their options: spending $X0,0000 to buy $X,000,000 worth of shares.

After exercising, they now own shares. The difference between the purchase price and the value of the shares is income, and OP needs to pay taxes on that income.

Note that OP isn't getting money, they are getting the shares, which they can hopefully sell in the future, either in an IPO or acquisition (or future internal round).

If they want to sell the shares to get money (to pay the taxes), there are tricky rules involved.

brobinson
Does AMT apply if you exercise and hold immediately after joining a startup (i.e., no money has been raised since joining/strike price has not changed)? From reading various articles online, it seems like it only applies to the difference in value between the strike price at grant time and strike price at exercise.
ropiku
No, it does not. It's the difference in value when you exercise. However you expose yourself to a big risk if you exercise immediately after joining, depending on how much the options cost you.
stockaway
I approached ESOfund in the past, and did not ultimately use them, but not by any fault of theirs. They were very professional, helpful, and knowledgeable about my options and provided very good information about my available choices, even ones that wouldn't benefit them (I did extensive independent research on the decisions available and on their suggestions).

I believe their mission statement is to take the risk for you, which includes AMT if necessary, in exchange for some percentage of your stock to be negotiated. There's no risk in reaching out.

As far as AMT, I believe (off-hand) it's 18% of all income if it would be greater than your existing tax burden. So if you make $100,000 and are currently taxed 30%, your current tax is $30,000. If you exercise stock (where the gain is difference between your equity plan and the value as of the latest 409A, multiplied by the number of options exercised), that counts against AMT.

In this case, $18,000 would be your normal income against AMT, and you could gain another $12,000 in AMT without paying any more. This means gaining approximately $66,000 in value from the exercise without paying additional taxes. You would pay 18% on the rest of the value gain. For another $1,000,000, you'd pay on the order of $180,000.

Note: talk to someone who does this professionally, perhaps a tax attorney, as my word is from memory based on my research from a while ago.

If you believe in your company, or at least believe the stock will be liquid, I absolutely recommend finding a way to exercise your stock. All the better if you don't take a tax burden.

I also found out there's some kind of tax thing where you can preemptively exercise options (at grant time?) which won't be taxed as a gain because the value hasn't changed, then you just get the options as they vest (though it's a little late for that now :P)

js2
some kind of tax thing where you can preemptively exercise options (at grant time?)

The 83(b) election?

cjbprime
83(b) elections are for restricted stock grants, not applicable to options.
not_that_noob
Some option agreements allow the early exercise of options, turning them into restricted stock. Because the value is usually low at seed stage, a good strategy is to exercise and then file 83(b) on the restricted stock. In this case, assuming you have this provision in your stock agreement, it avoids the mess of this exact scenario.
toast0
83(b) is applicable to options, if the options grant allows for early exercise, and you do exercise early (before the options have vested).
stedalus
Or if the option grant has early exercise.
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ryan-c
Federal AMT is 26-28% plus 7% for California AMT.
1024core
In such a situation: would it make sense to move to, say, NV and establish residence there before cashing out? At least you save the 7% CA AMT.
hueving
Won't work. California IRS hires bloodhounds to sniff this stuff out.

If you were employed in California when you were granted the options, you are going to pay CA taxes on them during exercise.

x0x0
I'm pretty sure that's not true.

It is true that you can't just rent an apartment in seattle, call it a day, and pay no income tax. CA will look closely at things like owning in CA, where bank accounts are, how many days you spend where (keep airline receipts), where you're registered to vote, where your kids/spouse live and attend school, etc. But it is possible to establish residency in a state tax haven and avoid that 12.3% CA income tax.

As always, if the amount of money is material, see a tax attorney.

hueving
No, when it comes to options, it's where you were a resident when they were given to you.
x0x0
Oh, apparently for NSOs. That is not true for ISOs, which the vast majority of startup employees will be granted. see Publication 1004 from the CA Franchise Tax Board, discussing ISOs [1]

   Nonresident of California on Date of Stock Sale
   Qualifying Disposition
   If you exercise an incentive stock option while a California resident or a 
   nonresident and later sell the stock in a qualifying disposition while a 
   nonresident, the income is characterized as income from the sale or 
   disposition of intangible personal property having a source in your state of 
   residence at the time you sold the stock. Accordingly, you are not subject 
   to income tax by California even though the services that gave rise to the 
   grant may have been performed in this state. [pg 10]
[1] www.ftb.ca.gov/forms/misc/1004.pdf
hueving
This covers the stock sale, but what about the liability of taxes from the exercise (diff between strike price and current value)?
x0x0
For ISOs, you're only subject to AMT on the spread between fmv and strike price at exercise. However, since there is (I think by law?) a 90-day exercise window after leaving employment, there's only 2 circumstances: (1) exercise while employed, and (2) exercise w/in 90 days after leaving employment. In both cases you're almost certain to be a resident of the state in which you were employed. Nothing I know of would require you to pay AMT to the state in which you were granted the options you exercised, but because it's unlikely for you to be a resident of a different state, it's a less interesting question.

Also, if your company takes off like a rocket, it's very much in your interest to not procrastinate on exercising vested options, because you want to minimize the AMT-taxed spread between FMV and strike. That increases the likelihood you're a resident of the state in which you were employed when you exercise.

TheRealWatson
We criticize companies when they do this sort of thing. We should not feel differently, let alone suggest, an individual does that too.
mattzito
Isn't it a different situation, though? Often companies move legal jurisdiction to save money on taxes, while leaving their executives, warehouses, assets, etc. in their original locations. In this case you're depriving the original location of the tax base while still consuming the same services.

If you as an individual want to physically move yourself to another jurisdiction to avoid tax liability, that's a different matter. You're then consuming services in the state that has opted not to tax you as heavily, presumably at least partially to draw you and your money to that locale. You would also then live there and spend money, bringing benefits to the local economy.

x0x0
it's weird how early employees / founders who've moved on from successful startups develop a newfound love of Seattle, including many fb posts on how awesome their new home is, eh?
jayzalowitz
At the very least, wait till Jan 1. That gives you an entire year for the stock to become liquid / sell.
jerf
Uh, that's a terrible idea. Don't exercise any options you don't have a plan right now for covering the taxes, especially if we're talking about millions as the OP says.
ksenzee
It's a much better idea than exercising the options on December 31, then having the tax bill come due April 15.
jerf
There's no way in which "exercise millions of dollars of stock options and hope that I'll be able to cover it" is a good idea. Merely increasing the runway doesn't fix the problem.
ryan-c
More than a year - the tax won't be due until April 15th of the following year. This will give you time to hold the stock for a year (getting long term capital gains rates when you sell).

Really though, talk to a CPA.

ericwaller
That's actually not the case, estimated tax is due quarterly (ex. for income in Q1 of 2016 for which your employer doesn't withhold taxes, you have to pay estimated tax by April 15, 2016).

But yeah, definitely talk to a CPA.

rpedela
Public or private company? Are you able to sell the shares immediately after exercising the options?
not_that_noob
In your situation, the company holds most of the cards, including if you are allowed to sell your shares to another party. I would talk with an attorney to see how your share docs are structured, and then explore how to work with the company to get value for your shares. For example, they might let you sell to an investor who really wants in. Keep in mind that the funding round valuation is somewhat irrelevant to you, as that was derived from the price of preferred shares, which have more privileges than your (likely) common shares.

The company will be motivated to do the right thing by you, to avoid litigation and spooking current and prospective employees. You might not get all the value you might have hoped for, but likely most.

hueving
>including if you are allowed to sell your shares to another party

How does this work with right of first refusal?

nwatson
I've wondered how that works too. I'd imagine you'd need a "firm offer" equivalent of cash-on-the-barrel from a third-party for your company shares, a non-further-negotiatable-contract-for-stock-purchase-with-lawyers involved. Then the lawyers would take that to your company, and if the company buys at the negotiated price the third-party loses, and if the company passes on it then the third-party gets the shares. You'd get the cash either way.
not_that_noob
A ROFR gives the company the right to pay the price you are being offered and acquire the shares underlying the options. A ROFR has the effect of making potential buyers reluctant to even deal with you, as the company can swoop in at the last minute and take the shares by paying what was agreed to. So effectively, it puts the company in control of the situation, and so best to get them on board to whatever's happening. First talk to an attorney though - with this amount of money at stake, it would be stupid not to.
pc86
ROFR is pretty standard for partnership businesses (I'm not talking about startups, but actual businesses operating on revenue), so I'm not so sure about it having any chilling effect on negotiations. My wife and I own 1/3 of a brick and mortar business is our town, and once we made an official offer two other people had to sign a document saying they were made the offer and declined (or whatever the legalese is).

It's pretty common and I've had no experience where it causes any issues. It's a cost of doing business when you're talking about equity in a business that has a lot of people involved.

leroy_masochist
Some companies also have fine print in their equity agreement that employee equity holders must get the board's approval for any sales of the company's equity prior to the stock being listed on a public exchange. Employees / former employees are thereby locked into being equity owners until the company in question goes public or is acquired.

If you leave the company, you have to exercise the options (typically within 30-60 days), and pay not only the strike price but the AMT on the difference between the strike price and the latest per-share valuation (i.e., the paper value of the options). So if you have options at a strike price of $50k that are now worth $5mm, you're in for well over $1mm of taxes payable -- now -- in cash.

My understanding is that this practice is legally dubious and has been challenged, but IANAL.

samstave
I am of the opinion this exists to screw "the little guy" - becuase few employees who leave companies have the upfront cash for both options and taxes.

This allows the company in question to effectively keep many shares/options that are given out to employees who were lured into the company with the "you're an equity partner!" line... only unicorns will pay all those little employees for the most part.

x0x0
2015: HN discovers golden handcuffs are for the employer, not the employee...
samstave
Regardless of the snark in your comment, there are many many people who need this spelled out for them.
x0x0
Very true, but (imo obviously) employees here are generally deluded: your relationship with management and founders of your employer is an inherently adversarial relationship. Pretending otherwise benefits them and screws you.
samstave
Yet another thing employees really need spelled out.

All the "we are a family" bs that any company pushes is generally crap.

If you fuckup in your family, you're generally not disowned.

In any company - you mess up and you can be cut...

If you have big enough issues to complain a lot to HR or speak disparagingly about your employer... Then you need to start looking for a new position, silently. HR is not the friend of the employee, mostly.

leroy_masochist
> All the "we are a family" bs that any company pushes is generally crap.

And don't forget the all-too-common practice of the hiring manager saying (or strongly implying) something to the effect of, "I'm a bit troubled by all the questions you seem to have about compensation, especially with regard to how much your options would be worth if you only worked here for a few years. I really got the impression that you were committed to our mission and a good cultural fit."

rhapsodic
Don't blame the companies, blame the government that writes the tax laws. There shouldn't be any taxes due until the shares are sold, and a profit is realized, like a normal everyday stock trade.
samstave
I didn't blame anyone. I stated my perception of the issue which informs my opinion... And I'll always be open to the fact I am wrong/naive - but it'd take a lot to convince me I am wrong on this issue after being fucked over by many Silicon Valley companies based on this...
leroy_masochist
> Don't blame the companies, blame the government that writes the tax laws.

True, but also blame companies when they fail to educate their employees about the mechanics of their equity grant -- or even worse, when they obfuscate in response to direct questions on that subject.

gameshot911
Using your example, can you not just subtract the $1M tax from the $5M payout? If the tax is actually due as a separate transaction before the payout appears in your bank account, wouldn't it be fairly easy to get a risk-free loan? Sure it's a lot of money, but isn't it 0 risk for the lender?
rlucas
You're missing the problematic part. It's when you've exercised an option that gives you a non-cash, notional ("paper" or "unrealized") gain, and you have to pay taxes on that in cash.
overdrivetg
This should really be solved by letting you transfer (or somehow attach) the shares to the IRS at the value they "believe" they are worth in lieu of the tax on those shares. Or better yet get rid of the whole AMT mess entirely.
zten
Isn't the problem that there is no $5MM payout? After paying a few tens of thousands for the below-market-price shares, you're the new owner of some shiny private shares, for which there is probably no market. In the future event of an acquisition or public offering, there's a chance of a payday.
arockwell
There is no $5mm payout in this scenario. This is the paper value of the shares, which you must pay taxes on since the IRS considers them income. In other words, the IRS thinks you have received something worth $5mm in value, so you must pay taxes on it.
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beambot
The $5M value is illiquid and speculative (based on startup valuation). In effect, this would make the bank a defacto investor, and most bank lenders are weary of startup stock as collateral. Definitely NOT zero risk!
tuckermi
I think the point is that there is same-year tax liability on the $5M value, but there is no guarantee on getting the $5M payout that same year (or ever, for that matter). When you exercise your options, you now hold shares in a private company, which may restrict your ability to realize the payout in various ways.
csense
The problem here is the IRS wants its $1 million in cash, but the only way you can turn those shares into cash is to sell them to someone.

If there's no one willing to buy at least $1 million from you, then you can't pay the IRS.

ksenzee
As you say, one possibility is to exercise your options, then sell the shares on the secondary market before IPO. It's worth at least talking to a company like Sharespost about whether those shares would be salable. They can give you an idea of what other employees have sold their pre-IPO shares for, and whether your employer allowed the sale.

I also second the advice about at least waiting until January 1, so you have another year to let the stock mature.

And if ever there were a time to talk to a tax accountant, that time is now.

sjg007
Are they ISOs or NSOs? If ISOs and you buy in first 30 days then you pay no taxes until you sell (and hold for 2 years from grant date, 1 year after exercise). But check that with an accountant or tax person. If NSOs then you have to pay tax on the gain.
voxy_dale
I did this exact thing last year, so a couple of things to be aware of. Firstly, many companies will not allow you to sell the shares to another party without their permission. You can talk to them about this but realistically, unless they generally allow this, they are unlikely to make an exception for you since it sets a precedent within the company, but you can try. Might be good to talk to a lawyer about this. Secondly, by exercising you will very probably expose yourself to Alternative Minimum Tax (AMT). If you don't know what this is, look it up as this can be VERY expensive. So, before doing any of this I would really talk to an accountant and possibly to a lawyer.
vessenes
On the flip side of this, it's very unlikely that the agreement bars you from _talking_ to the other shareholders about buying you out.

The employee does have some leverage here, to wit, he/she can just ask corporate to make an offer, and if the offer isn't appealing, can canvas all existing investors and say the shares are going to the highest bidder. Someone will buy them, whether the company, to get the headache dealt with, or an investor who's happy to add some common at a nice price.

Whatever the ROFR says, corporate legal will think many times before going toe-to-toe with a recent large investor who wants to buy some more stock.

pc86
You are usually not legally allowed to sell stock from exercised options to anyone without explicit permission from the company. It has nothing to do with ROFR.
vessenes
But, you miss my point. If Peter Thiel wants to buy your shares and holds N% of the existing company, that deal will get done, regardless of the company's legal rights. It's social.
voxy_dale
Actually, this isn't correct. Sure, you can talk to whatever shareholders you want, but if the stock is still privately held the company can actually dictate whether you can sell the stock or not, and to who. Company does not have to buy it back, and doesn't have to allow a sale if it does not want to buy it. Trust me, I've been there.

Now, some companies might not restrict sale, but that'd be somewhat unusual.

austenallred
I know this isn't the advice you're looking for, but since at least $X00,000 (and most likely $X,000,000) is at stake you should definitely talk to a lawyer.
beefhash
It may not be the advice OP is looking for, but it's the advice OP needs.
blizkreeg
How does one go about looking for a lawyer for such a thing?
mmastrac
Ask for recommendations from friends. Ask for a recommendation from your accountant. If that fails, call up a startup-specialized lawyer and ask them for advice or to be referred to someone they trust.
samstave
Tax lawyer.

Call up Orrick and ask for startup advice - they will direct you to the right person.

steven2012
At this point, if there is no way to sell those shares that you exercise immediately, it makes the most sense to bide your time (EDIT: ie. not leave) and wait for the IPO. It might be 1-2 years, but if it means giving up a millions of dollars, I would just tough it out. Don't think that these opportunities come all the time, this is your chance to make a lifetime's worth of money, you hit the lottery so don't squander this opportunity. 1-2 years more won't be a big deal in the grand scheme of things.
leroy_masochist
Right, but this person's problem is that they don't have the cash to pay for the taxes associated with exercising the options, making the "hold patiently" plan problematic.
bagels
I think the proposal is that the person not leave, instead of leaving and needing to exercise.
mcfunley
I was in a similar situation two years ago. I'd advise having both a plan and a backup plan before you pull the trigger on leaving.

This is generally pretty good, if verbose:

https://github.com/jlevy/og-equity-compensation

Talk to esofund and friends ahead of time, and see what their offers for your company's stock are, and make sure they're acceptable to you if you think you'll have to go that route.

Don't count on definitely being able to sell the stock to finance the taxes. I left after seven years in very good standing (I believed) but when I went to sell the deal was shut down [1]. Luckily I had a backup plan and I was ok [2].

[1] Had a handshake deal with an investor in the company, then the investor went silent on me. When I followed up he said the deal was "just much too small." I reached out to the company for help, and they said they'd actually told him not to buy from me. I never would have known if they hadn't decided to tell me for some reason. The takeaway is that the markets for private company stock tend to be small, and the buyers care more about their relationships with the company than they do about having your shares. Even if the stock terms allow them to buy, and they might not.

[2] However I was trying to sell for roughly double the current (public market) price. The private/public valuation gap is real! Don't put too much stock (haha) in the value at the last tender offer. If you can sell privately at close to that price it's possibly smart.

angersock
I reached out to the company for help, and they said they'd actually told him not to buy from me.

See, it's shit like this that further erodes any faith I have in the ponziconomy of startupcanistan.

pc86
Based on what? A conversation between two people you've never met, as relayed to you online by someone you've never met?
Sikul
With regards to [2], are you saying the private price at the last tender offer was much higher than the current public price?
mcfunley
Both the price of the final pre-IPO tender and the sale price I privately arranged were higher than the current public market price.
gyardley
No experience with ESOfund, but I've worked with brokers before to sell some of my illiquid, private company stock on the secondary market. It really depends on what restrictions have been placed on your stock. If you can sell some of your stock to cover your tax obligations, that's a decent way to go.

E-mail me if you want, I'm happy to chat about the situation / introduce you to the brokers I worked with.

phillytom
Note there are other firms that are in this space as well - Akkadian Ventures, Founders Circle, 137 Ventures, and VSL. That said, I can't speak from experience on any of them.

Having the CEO (and the board) in your corner on this will make the likliehood of a good outcome for you better.

OliverJones
It's possible your options expire 90 days after you leave the company's employment, or some such thing. I suspect that's the case. It doesn't make sense to just walk away from those options, though.

Ask the company's CFO or somebody if there's any way they can buy back some of your shares at or near market price. If they can do this, or if they can let you sell them to a third party, you can sell enough shares to raise the cash to cover your tax liability and hang on to the rest.

Or, maybe the company can grant you an exception to the "exercise it or lose it" rule that kicks in when you leave. You won't know unless you ask.

You have some leverage. With the number of shares you have, they'll probably need you to cooperate in any transaction they carry out.

ESOFund is a possibility. But your company has to be a participant. And, they grab some of the upside and a lot of the downside.

At any rate, you probably should get yourself a decent tax accountant (or maybe lawyer) to help you navigate this. It's worth paying for top-drawer advice. That person will know how to recommend an honest EOFund-like broker if that's the route you go.

(Congratulations in advance, by the way!)

kevinpet
To clarify, if you find a buyer who is interested in buying (would need to be a qualified investor), the company can exercise their right of first refusal to buy the shares from you at that price, but they cannot generally prevent you from selling. If I were in your shoes, I would probably want to have the deal lined up ahead of time before exercising.

Consider going through the CFO or CEO to see if any of the company's existing investors would be interested in acquiring some of your stock. This has the advantage to the company of not bringing in an unknown outsider.

Edit: I see further down that some companies have further restrictions beyond right of first refusal. I'd never heard of that before, but then, I'm only on my first startup where I think my options are worth anything.

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payne92
First, talk with a lawyer and an accountant. The at-stake amounts are large enough that's short money.

Second, I'd strongly consider doing some/all of this after Jan 1. That will put your ISO+AMT tax into 2016, which will push your tax bill on this transaction to April 2017. (It may make sense to do a smaller amount before year end, depending on your current AMT situation).

(And make sure you make estimated payments (plus withholding) for 2016 that exceed 110% of your 2015 bill -- that way, you can kick the final bill all the way to April 2017).

Finally, the penalty for paying late is not THAT bad: given the amount of money, it may make sense to file in April 2017, pay what you can, and work out a payment plan with the IRS. You are not the first to have this scenario happen.

zippy
I would call the IRS up and ask them what a payment plan would be like for an n million dollar liability, and then weigh whether that scenario is worth the exercise. Because at this point, this is a question of risk tolerance, and risk vs reward.

For some people, a lifetime of debt, no matter what the possible reward, is unbearable, whatever the odds of the outcome. For others, who feel this is their best shot at wealth, and who are comfortable with the risk, it's an easy choice to buy the options.

But yes, get a tax advisor who is familiar with this specific situation (exercising stock in whatever state/country you live in, e.g California) and find out what the various scenarios are.

Anecdote: I and co-workers of mine have been in this scenario. It worked out for some and was a burden for others. Good luck!