There's no limit to the 409A valuation of a company. The more successful your company becomes, the higher the 409A valuation gets. Your tax bill can grow endlessly, making options more expensive to exercise as time goes by.
Exercise tax bills can become pretty extreme, climbing to reach as much as 10x higher than the strike price you pay to actually buy the shares.
Plus, startup valuations can skyrocket quickly. Some companies have reached unicorn status ($1 billion valuations) within three years of founding — achieved by Pinterest, Snapchat and Square.
The general rule of thumb is: if you believe your company will continue to grow and have a great exit (IPO or get acquired), the earlier you exercise is usually best. That’s because you’ll pay less when exercising and start the clock on long-term capital gains (another tax you pay when selling shares) so you can realize more gains when you sell them. But here are some other factors to consider.
409A valuations play a big role in the cost of exercising your options, so they’re an important consideration for timing.
You can start by finding out your company’s current 409A valuation. This number is likely available on your equity management platform (Shareworks or Carta, for example).
What about forthcoming 409A re-valuations that could bump up your exercise tax bill? Hopefully, your company will proactively tell you when a re-valuation is on the horizon — either the annually scheduled update or a re-valuation due to another trigger event, like an upcoming funding round.
That said, if you’re thinking about exercising, it’s a good idea to ask your company about the timing of 409A valuations. Note, however, that they can never be 100% sure of timing because a material event may happen unexpectedly.
It’s also helpful to ask about blackout periods, as companies often prevent employees from exercising options around the time of a fundraising round, including an IPO. Exercising before a fundraising round and subsequent increase in 409A valuation could save you money, so you’ll want to try to be aware of upcoming rounds and associated blackout periods.
Ultimately, choosing whether and when to exercise your options is an important decision with many moving parts to consider. Our full guide to exercising includes useful information that can help you make the call with confidence.
Sign up for free to get full access to our tools and see how much it could cost to exercise your options. If exercising your options creates a tax bill you can’t afford, Secfi can help cover the costs.