When you first took that early stage startup job you were likely enticed by startup lottery tickets called ‘stock options’. These options to purchase shares in the company were granted to you at some exercise price and they vested over a number of years. Lets assume its been a couple of years and you’ve decided to leave to start your own company. Did you realize that in most cases you need to exercise those options within 90 days of the termination of your employment? If you don’t exercise those options you’ll lose them. Ouch!
Here’s how it works. Lets say you were granted 30,000 options at a dollar a share that vested over three years. You’ve been at the company for two years and you’re ready to leave. Within 90 days you need to write a check to the company for $20,000 to exercise your option to buy 20,000 shares (the amount that has vested). Again, ouch! You’re leaving the company and the absolute last thing you want to do is write them a check EVEN if you think the shares will be worth far more in the future.
So what do you do? My advice to employees taking early stage jobs at startups is to negotiate their employment contracts better. The easiest language to add to your agreement is a simple provision that requires the company to ‘loan’ you the money to exercise your vested options upon termination of your employment. In the case of this loan no money would change hands AND you only pay when you can sell your shares (the shares are the only collateral for the loan). Remember, your holding period does NOT begin in this case from an income tax perspective. If you want to begin your holding period upon exercise you need to ensure that the loan is full-recourse (i.e. you own the money even if the shares turn out to be worthless). My advice? Make sure the loan is non-recourse AND don’t worry about paying the higher tax rate. Good luck and keep exercising.