When storms hit, it’s human nature to want to hunker down and wait out the bad weather. No need to poke your head out until you see sunny skies, right? But stock options are an investment, and volatile times are not when you want to make knee-jerk investment decisions, or freeze due to uncertainty. Inaction is a choice in itself — so by not doing anything, you’re making a decision that could end up costing you.
It’s important to remember that like any financial investment, equity should be viewed like a long-term investment. But you may want to — or need to — make short-term decisions, even during cloudy market conditions.
The silver lining of a down market is that it could lower the cost to exercise (i.e. buy) your stock options. Down markets are normal — happening on average every 3-4 years, historically.
It’s also not uncommon to be making a job transition during these times. And that means you’ll likely have a unique window of time (called the post-termination exercise window) to exercise your stock options or take advantage of beneficial tax treatment.
Whatever your situation, now is a good time to make a plan for your equity.
Do you believe in your company in the long term?
This is the first question you’ll need to answer when deciding whether to exercise your stock options in an uncertain market.
Do you still believe in the long-term vision of the company? Do you still believe that they have a strong product-market fit and will stay competitive in their market? If you believe in your company’s prospects, it might make sense to invest in the company, by exercising your stock options.
Even if your company does go through a period of hiring freezes or layoffs, it doesn’t necessarily mean the company is on the rocks — it could mean your leadership team is just extending its operating runway to better weather a market downturn.
A timely example is Airbnb, which laid off 25 percent of its workforce (1,900 employees) in May 2020 and then went public seven months later. The company saw a valuation decline in April 2020, but it quickly recovered after going public.
Here’s how to plan proactively today to get the most out of your equity:
1. Get comfortable with the exercising process
If you don’t have a plan for your stock options, this is a good time to start getting familiar with exercising.
Why? Exercising can be costly and come with an unexpectedly high tax bill. Start by understanding exactly how much it will cost to exercise your stock options today, versus if you wait to exercise in the future. Also think through best- and worst-case scenarios: If your company fails, do you feel comfortable potentially losing your investment in your stock options?
If you need some help visualizing your numbers, check out Secfi’s Equity Planner.
The exercising process effectively consists of the following steps:
- Pay your company the strike price to buy your stock options.
- Pay any associated taxes when you exercise. (Note: This is the key reason you want to have a plan! Taxes are not automatically calculated for you or taken out if you’re earning ISOs. Plus, the tax amount can, and likely will, change in the future).
- When you file your annual tax return, pay any additional taxes you might owe for owning your shares.
We recommend working with a financial advisor, who can guide you through the exercising process and help you make tax-smart decisions along the way. Now is your chance to get ahead of tax planning and make choices that help you retain your hard-earned equity. (Last year, people paid $11 billion in unnecessary taxes, mostly because they were waiting for their companies to IPO. You don’t want to be part of that statistic!)
2. Know your post-termination exercise window
Stock options do have an expiration date, and if you leave your company, that date could be sooner than you think. Even if you stay with the company, unexercised options expire after 10 years (just ask Elon Musk).
To get the most out of your stock options, you have to understand your post-termination exercise window — the period of time you have to exercise your vested incentive stock options (ISOs) if you leave the company. Most employers allow just 90 days to exercise options before you lose them, so this deserves a spot at the top of your priority list, especially if you’re going through a career transition.
It’s also worth asking if your employer offers an extension beyond 90 days for exercising your stock options. Even if the company offers one, you may have to be employed for a specific amount of time, or there could be other criteria — for example, offering a multi-year window if you work there at least two years.
Extended post-termination exercise windows create additional flexibility for you to plan around. That said, extended window or not, you’ll lose the tax benefits of ISOs after 90 days when the options are converted to non-qualified stock options (NSOs). Essentially, ISOs are the more tax-advantaged choice.
In any situation — whether it’s a 90-day or 10-year window — there are many different strategies you can explore. While the best strategy is usually the one that minimizes tax and maximizes value, it's not a black or white solution. Your personal plan should be based on your specific financial situation and goals. An advisor can help you evaluate factors such as exercise costs and tax implications, to determine what choices and timing make sense for your personal financial situation.
3. Make low valuations work to your advantage
We get it — a startup getting a low valuation doesn’t exactly sound like a good thing. But think about it like this: lower valuations can mean reduced taxes when exercising, which could also result in increased upside for you. That’s because you’re taxed on the difference between your strike price and the fair market value (or 409A valuation) of your stock options at the time you exercise.
Many companies may be lowering valuations to reset alongside the market, precisely so that they’re better set up for an eventual exit. In the short-term, lower valuations provide an opportunity for you to potentially invest in your company at a lower total cost (remember, buying stock options is an investment).
Current market conditions and career transitions can be disconcerting — but turbulent markets and declining valuations are not the time to forget about your equity. In fact, it’s the opposite. This is your opportunity to talk to your advisor about strategic moves you can make today to save on taxes and help you accomplish financial goals in the future.
Equity is an investment, so you should treat it like one. You've already been investing your time and hard work into the company. But you also want to remove emotions and rash judgements — such as getting thrown off by down markets — when evaluating the long-term value of the company, your equity, and your overall financial picture.