3 things your financial advisor should know about equity

Financial advisors aren’t just advisors. At times, they play the role of coach, sounding board, or even therapist. That makes advisors invaluable in helping you plan for financial needs, make decisions on investments and insurance, and save for short- and long-term goals such as education and retirement.

That said, not all advisors are created equally. The average financial advisor doesn’t often interact with startup stock options, meaning they may unknowingly give you cookie-cutter advice that isn’t actually right for your situation. Advisors are trained to help you reduce risk, but if they’re not familiar with startup options, they may be taking a myopic view of risk that doesn’t actually apply to your situation.

If you have stock options, it’s important to seek out an advisor that understands startups — and knows these three things about equity.

1. The TOTAL cost of exercising stock options

Most financial advisors understand Restricted Stock Units (RSUs), which are fairly simple and common. But does your advisor have a firm grasp on the difference between Incentive Stock Options (ISOs) and Non-Qualified Stock Options (NSOs)? While they may at first appear similar, they have very different tax treatments (ISOs being more favorable), not to mention strict timing rules.

For example, if you leave a company and don’t exercise your ISOs within 90 days, the ISOs automatically become NSOs, which could trigger a bigger tax bill. If your advisor isn’t familiar with the nuances of equity, they may not know to encourage you to exercise.

In another situation, the cost to exercise might be huge, and open you up to a massive amount of risk. If your advisor doesn’t have a great handle on those little nuances, you could get an unexpectedly large tax bill.

2. The real risks of exercising

You might be wondering if you should exercise at all, when you should exercise, or how you should exercise. An advisor who understands equity can help you with these questions. There can be big differences between a Series A startup and a Series D startup, and your financial advisor should give you advice based on your company’s stage, and what your personal financial goals are.

For instance, let’s say you join a Series A company. You get a strike price of $0.05, and it costs you $5,000 to exercise all your opinions. Are you going to absolutely derail your financial life if you don’t recoup $5,000? Probably not (and if so, you should work with an advisor on other aspects of your plan). But if it’s a Series C or D company, it could cost you $50,000 to exercise further along in the maturity cycle, which might change your decision.

One of the crucial questions people ask online is, “I think my startup will do pretty well — but should I really put 15% of my take-home pay into exercising my stock options? What’s the opportunity cost of just buying an S&P 500 index fund instead?”

The bulk of online advice says to wait until your company exits to exercise using a cashless transaction. According to these online speculators, this will allegedly make you a millionaire, “reduce your risk to zero,” and allow you to invest in an index fund. But while this advice may work for some, this could be the wrong call for people working at specific startups. And it doesn’t actually reduce your risk to zero; it’s just reducing one risk vector. You still have the risk of getting laid off or wanting to change jobs, and at that point it would be much more beneficial to have already exercised.

3. The nuance of taxing and selling options.

Selling is a complex issue. There are big decisions that need to be made around if you sell, how you sell, and when you sell — and what’s best for you depends on your specific situation and life goals. No cookie cutter solution is right for everyone.

This is why it’s so critical to have an advisor who understands equity as well as your goals. Let’s say you’re looking to buy a house in the next two years; it might be best for you to sell in a tender offer and reduce risk. Or, maybe it’s better to sell in a secondary market, or wait until IPO when everyone’s lockup period ends. Or, you may want to sell on day one for tax purposes. You have plenty of choices, but determining what’s right for you is just as much art as science. You need an advisor who understands both sides.

As an anecdotal story, one of Secfi’s financial advisors recently met with a client who worked at a startup that was founded in 2018, and recently raised a Series C round of funding that valued the company at more than $1 billion. It would cost the client about $170,000 to exercise his vested stock options — along the way, triggering a massive AMT tax bill.

Using Secfi’s AMT tax calculator, we found the client could exercise $3,500 worth of his vested stock options today without triggering AMT.

The client was skeptical — $3,500 in stock options seemed like a drop in the bucket, why even bother? What we helped unpack was that he was paying $1.26 per share for equity that investors were valuing at $36 per share in the most recent round of funding. He was investing $3,500 in equity that investors valued at $100,000.

By exercising today, he could potentially sell at the long-term capital gains rate in the future, use those proceeds to pay taxes on exercising more options, and still do all this well before there’s an exit.

This story underscores how nuanced these equity decisions can be. Once you start unpacking different layers, you start to see money and risk differently. In this client’s case, he saw the amount as small — but it gave him a massive amount of opportunity and flexibility with his career. An advisor who understands equity will help you unpack those layers and explore all of your options so you can make the best financial decisions.

At the end of the day, the most important thing is that your advisor understands startup equity and asks the right questions about your situation to determine what’s best for you. If you’re interested in talking to a Secfi advisor, we’re here to help.