Editor’s note: A version of this question originally appeared on Reddit.
I recently joined a mature startup that has 3,000 employees and good funding. Management says we’ll go public in the next 1-2 years, although my colleagues think it’ll be more like 3-4 years.
I’m earning $100,000 in stock options vested over four years. When I get those stock options, does it make sense to immediately sell them and invest them somewhere more stable, like an index fund? Or should I keep my stock options and wait until the IPO?
It seems risky to put so much net worth into a single stock, and I might be able to experience some appreciation in an index fund. Although it’s not even clear who I’d sell my stock to if the company is not yet public.
First, congratulations on the new role! It’s exciting to work for a mature startup that sounds like it’s growing and on a good trajectory.
Long answer short: If you want to sell your stock options before an exit, private secondary markets exist, although there may be restrictions on how, when, or if you can sell. An estimated $30 billion in private company shares trade hands every year on secondary markets and in private tender offers, according to analysts at Sacra. There are good reasons why people decide to sell their private shares early, despite their relatively high costs, taxes and the risk of losing out on potential future gains.
Longer answer: Every startup employee should build a plan for their employee stock options. As part of this plan, you should know:
- What type of stock options am I vesting? Am I vesting incentive stock options (ISOs), non-qualified stock options (NSOs) or restricted stock units (RSUs)?
- What is my vesting schedule?
- If I’m vesting ISOs or NSOs, what is my strike price?
- What is the company’s current 409A valuation (also known as fair market value)?
- Does my company allow early exercise?
- Does my company allow employees to sell on secondary markets?
Using this information, you can begin to chart out potential outcomes for your stock options.
The vast majority of people with equity in late-stage, venture-backed startups decide to hold onto their shares and wait for an exit, either in the form of an acquisition or initial public offering. There are two major reasons why — secondary markets are difficult to navigate, and shareholders worry that they may be prematurely leaving value on the table by selling their equity early.
First, the difficulty inherent in selling on a secondary market: Unlike public markets, which have a high volume of buyers and sellers and instant price discovery, secondary markets are built on individual transactions, with opaque financial assumptions on both sides of the transaction. Deals can take weeks (and sometimes months) to complete, and buyers will factor their added risk into the prices they’re willing to pay for privately held shares.
For sellers, secondary markets make sense when the seller feels that the value of their shares is peaking, or if they need a large amount of money immediately and are willing to forgo future potential gains to get that money today.
Exercising shares and immediately selling them may trigger the highest possible tax rate, and any gains you make on the sale will likely be taxed as ordinary income. You’ll want to work with your CPA or licensed financial professional to figure out taxes you might owe if you decide to sell your shares early.
Ultimately, when and how you exercise (and later sell) your stock options is a personal decision that you should make with licensed financial professionals. Hindsight is always 20/20 and the future is not guaranteed — you might be kicking yourself in a couple years if the company goes public and soars in its market debut, or you might be congratulating yourself for selling early if the company fails before IPO.
In general, I like to think of stock options like any other investment in a balanced portfolio — if I had the opportunity to purchase this private company’s shares at this specific price, would I do it? How long would I hold onto the shares? What percentage of my net worth should I tie up in a single asset?
In the end, these are highly individual questions, with highly individual answers.
- Vieje Piauwasdy, Director of Equity Strategy, Secfi
Do you have a question about your stock options? Email us at firstname.lastname@example.org