If you’ve just found yourself laid off from a startup, you are far from alone. StartupGenome states that 74% of US startups have had to lay off full time employees, and it’s been reported that over 40% of Nordic startups and over 60% of French startups are enacting some form of layoffs.
Being let go is always hard, but if you have stock options as a startup employee, it’s also the time to make some very important decisions about your financial present and future. What you do with your equity could be a life-changing event. It’s key to find a way to manage your finances so you can live today while investing in your future.
Exercising your stock options can be an expensive process. While making a major investment just as you find yourself out of work might feel like a huge risk, in some cases it may be an opportunity for incredible gains you should not pass up without careful consideration.
To help you figure out what’s best for you and what you can afford, here are some key questions to ask yourself and some tips for getting the answers.
Please keep in mind that laws and procedures vary from country to country, so I’ve given an example of how things work in the US, but these considerations are still good to keep in mind regardless of where you’re facing this scenario.
How do I know how much equity I have?
Stock options are something you would agree upon with your company, in most cases shortly after you started work. In addition to your employment contract, you should have a separate document called a stock option grant agreement that details the terms of your equity. If you are unsure if you have such an agreement or if you don’t understand it, you should consult with your HR or Finance department, or your company’s equity management software, if they use any.
Grant terms include the vesting period, which means how long you need to have worked for the company to have the opportunity to vest stock options and the right to exercise those and convert them to shares. For example, after one year of employment, you might be able to exercise into shares 25% of your granted stock options, and after four years, 100%. Terms vary from startup to startup.
Alright, I know how many stock options are vested. What do I stand to gain from exercising my stock options?
Let’s say you started working for your company in 2016, when their stock was worth $10/share. Now, four years later, you’re laid off and you find that you have the option to buy 1,000 shares. What this means is you get to buy that stock at the price it was worth when you signed on in 2016: $10/share.
You have the rare opportunity to buy something today at its past price. Now in 2020, let’s say that stock is worth $100/share. So, the basic theory is that you can spend $10,000 for those 1,000 shares, which are now worth $100,000. So your profit would be $90,000 worth of stock. But…
How much does it really cost to exercise my options?
Now let’s set up this example for the US. Your “exercise cost” is, let’s say, the $10,000 it cost to buy your shares plus taxes on your theoretical profit. The tricky part is figuring out those taxes. Since your company isn’t yet publicly traded, you might not know exactly what your shares are worth at the moment.
In the US, in order to find out, you need to ask your HR/Finance department for the latest “409A,” or the current common share fair market value. “409A” refers to a section of the 2004 American Jobs Creation Act, which states that each company must get a valuation every year and when it closes a new financing round. Your company must provide you with this number.
Supposing the current share fair market value is $100. So your exercising cost is $10,000 to buy the shares, plus taxes on that $90,000 profit.
Some tax points to watch out for:
- If you have Incentive Stock Options (ISO), you may need to pay AMT (Alternative Minimum Tax) on that profit rather than being taxed like normal income, which is great because it may be lower.
- Non-Qualified Stock Options (NSO) are taxed at normal income rates.
How long do I have to decide what I want to do?
In the US, you ISOs by law provide up to 90 days to decide if you want to exercise your options or not. If you need longer, you can ask your company to extend your deadline. Some will, but they are not required to do so.
You should also note that if you have ISO and extend them beyond the regulated limit of 90 days, they automatically become NSO and so you might need to pay higher taxes. You should consider these time frames when deciding when is the best time to act for you.
Can I afford to exercise my stock options?
This investment, like all investments, carries risk that must be considered in your decision process. If you have the money to pay for your stocks and the taxes out of pocket, that’s great. Still, you’ll want to remember that this is an illiquid investment – you’re gaining value in stock, but you can’t expect to gain access to that cash any time soon. You need to be stable enough to handle that financially.
A lot of people don’t have the funds on hand to buy their stocks outright, especially given layoffs and halted hiring processes. If that’s the case, you can consider:
- Digging into your savings or borrowing from friends and family.
- Services like my company, match former startup employees with investors who provide the capital to exercise your stock options in return for a share in the future gains.
- Personal loans: keep in mind that you’ll need to pay back these loans and interest whether or not you ever see profit from your shares.
What is the risk?
Investing in a startup is considered a high-risk investment. Depending on the success of your company and changes in the market, the value of your shares could decrease, or your startup might fail and the value diminish completely.
What could be the reward?
Just look at early employees at giants like Facebook to get an idea of what these stock payouts can really look like.
Owning stock in the right company that eventually goes public or exits for a significant amount can be a life-changing event, reshaping your financial future and buying you immense freedom.
Times are tough, but not impossible
Essentially, don’t let the thought that the process seems complicated or expensive discourage you from looking seriously at the opportunity in front of you. Even in complicated times like the coronavirus pandemic, there are ways to be forward thinking and take advantage of the work you put into your startup and own your hard-earned equity
You worked hard for those stock options, and they’re yours. If you are optimistic and confident about the company and believe it’s going to succeed, don’t let the complicated and expensive process take away what is rightfully yours.