Fast-forward to September 2020. Rumors of an IPO start to spread, and you look into your ISOs again.
Now, the 409A value has grown to around $35. This increases your tax liability to $596,758, bringing total exercising costs to $671,748.
Nearing the IPO, at some point you’re informed about a deadline: the last chance to exercise your stock options pre-IPO.
After that deadline, there’s a blackout and you won’t be allowed to exercise.
Needless to say, exercising your ISOs has been pretty much impossible from the start and it’s only gotten worse with each 409A update.
So instead, you just wait for the IPO.
But that’s a shame because if you exercise at the IPO by selling shares to cover the cost, you won't qualify for long-term capital gains. You have to hold on to your equity for two years after grant and one year after exercise in order to get that preferential tax treatment. This is where the tax savings are forfeited.
Don't get me wrong, both are AMAZING outcomes... But $1.4 million is no small difference 😅
Even at the cost of $1.1 million right before the IPO, that's still a 128% net return. Not too shabby.
(Note that the $1.4 million is a difference in net gains so the $1.1 million spent on exercising the ISOs is already factored in.)
We have a culture of employee equity, which I love. We're definitely moving in the right direction.
The equity vehicle of choice is the stock option, but it’s not without its flaws. Paradoxically, it’s the biggest success stories that bring out the best and the worst of how they work.
So, startup employees: Make sure you're being conscious about your stock options. Know the potential risks and benefits of exercising. If you don't know how to approach this topic, talk to an equity strategist or people who do know. There's too much money on the table to just ignore it.